Submission: Telecommunications Amendment Bill
Presented to the Finance and Expenditure Select
Committee
11 August 2006
Bronwyn Howell
New Zealand Institute for the Study of Competition and Regulation Inc. and
Victoria Management School, Victoria University of Wellington, PO Box 600,
Wellington, New Zealand. Email [email protected]
Acknowledgement: The author wishes to acknowledge the helpful comments provided by
Glenn Boyle, John de Ridder, Lewis Evans, Mark Obren and Bryce Wilkinson in the
preparation of this report. Any errors or omissions remain the responsibility of the author.
The views expressed are solely those of the author, and are independent of any that may be
held by either of the entities with which the author is contractually aligned.
The Author
Bronwyn Howell is Lecturer, Corporate Management, at Victoria Management School, and
Research Associate, New Zealand Institute for the Study of Competition and Regulation. She
holds BA(Hons) and MBA(Distinction) degrees, and is currently undertaking doctoral studies
at Victoria University. She has twenty years experience as a practitioner in, and seven years
experience as an academic studying the structure, conduct and performance of, Information
Communication Technology (ICT) markets.
The author is one of only a very small number of academics who have researched and
published in the internationally peer-reviewed academic literature on the New Zealand
telecommunications markets, and the relative performance of the New Zealand markets
compared to those in other countries. To the best of her knowledge, the author is the only
New Zealand academic who has published extensively in this literature on the diffusion and
utilisation of Internet and broadband technologies as observed in the New Zealand market.
A full list of the author’s publications is attached as an annex to this submission.
Declarations of Interest
This submission has been prepared without any financial assistance from any other party.
The author declares that she was contracted at various times by Telecom New Zealand,
Charles River Associates and Russell McVeagh to provide independent analysis of a variety
of aspects pertaining to the Section 64 Inquiry in 2003. She has undertaken no contracts for
these or any other parties in respect of local loop unbundling since November 2003. She has
participated in the provision of a variety of reports relating to the diffusion and utilisation of
ICTs for the Ministry of Economic Development between 2000 and 2004, in the course of her
employment at ISCR. She has not been the beneficiary of any contracts let by the Ministry
since 2004.
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Executive Summary
The Telecommunications Amendment Bill introduces a number of new regulatory obligations
upon the incumbent telecommunications provider Telecom New Zealand, including local loop
unbundling, enhanced bitstream service provision and co-location. The changes have been
proposed following a ‘Stocktake’ of the New Zealand telecommunications market, the
findings of which were announced in May 2006.
The authors of the Stocktake have concluded that these changes must be introduced because
of a lack of competition in the markets for broadband services that they claim is responsible
for New Zealand’s low position in the OECD in broadband uptake. They claim that, in the
absence of competition, Telecom has invested insufficiently in its broadband infrastructure,
and that consequently the products offered are of lower quality than those in other OECD
countries, that there is lack of product variety, and that megabyte caps are leading to pricing
that is high by international standards. As a consequence, they claim New Zealand is falling
behind its OECD competitors in capturing the economic benefits of an information economy,
and will be unable to meet targets set in the Digital Strategy of becoming a top quartile
performer in the uptake of broadband services. Existing interventions, it is claimed, are
insufficient to meet the objectives, as fewer than required of new broadband connections are
sold by companies other than Telecom. Thus, they conclude that the additional interventions
are required in order to meet the Digital Strategy targets, address the perceived investment
‘problems’ and to ensure that New Zealand conforms with the regulatory conventions adopted
by most other OECD countries.
This submission contends that there are many methodological and logical flaws in the process
by which the Stocktake analysis has been undertaken. These flaws have occurred principally
because the Stocktake authors and their key advisers appear not to have consulted
extensively within the large body of academic literature available that would have usefully
informed this inquiry, and have undertaken empirical analyses of an unscientific nature to
support their process of diagnosing ‘problems’ and prescribing ‘solutions’. Consequently, the
majority of the Stocktake conclusions, and the remedies proposed to address them, are subject
to a substantial degree of doubt in both their accuracy and efficacy. Indeed, most of the key
conclusions are at considerable variance to what would be expected given the substantiated
findings in the body of theoretical and empirical literature. There are very real risks that very
costly mistakes will be made if decisions about proceeding with the unbundling proposals are
based upon the Stocktake recommendations alone.
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1.
Broadband Uptake as a Driver of Economic Growth a Flawed Assumption
The analysis in this submission demonstrates that the use of broadband uptake statistics as the
sole proxy for measuring economic welfare generated in a knowledge-based economy has no
theoretical or empirical substance. As it simply measures the diffusion of a single variant of a
transport technology in a highly technologically volatile market involving a very wide range
of technologies that perform all the tasks of creating, storing, transporting, processing and
utilising digital information, it is a very poor metric for measuring what is a very complex,
and highly uncertain relationship between investment and use of all ICTs and the economic
growth that they are associated with.
The empirical and theoretical literature confirms that there is no simple and direct causal
relationship between broadband uptake and GDP growth. Rather, the empirical evidence
suggests a highly complex set of interactions whereby GDP per capita itself is likely
extremely influential in determining a country’s diffusion pattern for broadband technologies
(Figure i). Any relationship in the opposite direction is likely to be small, hard to measure,
may take many years to accrue, and will, like the expectations originally held for the
economic growth resulting from investment in computers, be most probably very much
smaller than initial optimistic estimations have suggested. It is highly unlikely that high
expectations of a substantial improvement in New Zealand’s relative economic wealth will be
realised simply from an increase in the number of broadband connections sold.
Thus, high
expectations of GDP per capita increases associated with any policy designed to accelerate
broadband uptake are unlikely to be fulfilled.
Figure i
OECD Broadband per Capita and GDP Per Capita, December 2005
70,000
GDP Per Capita, $USD, PPP, 2004
60,000
y = 10232x0.3805
R 2 = 0.5841
50,000
40,000
30,000
20,000
10,000
0
0.0
5.0
10.0
15.0
20.0
Broadband Penetration per 100
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25.0
30.0
Moreover, to measure ‘success’ or ‘failure’ of the Digital Strategy using a simple ordinal
ranking in a single statistic, in isolation from the cardinal metrics underpinning that ranking,
is likely to be highly misleading, given that a very large number of contextual factors,
including measurement error, comparability of data and differences in the underlying
economic, demographic and geographic characteristics of the countries being compared, will
influence the significance of the statistic completely independent of the characteristic being
examined.
Therefore, any policy ‘target’ predicated upon achieving a relative rank in
technology uptake per capita that does not take into account these contextual factors is
conceptually flawed.
2.
No Evidence that Low Broadband Uptake Harming Economic Performance
When taking a broader perspective incorporating contextual factors and a variety of metrics,
there is little evidence that leads directly to the conclusion that New Zealand’s low broadband
uptake levels are harming the extent of growth of economic and social welfare arising from
the use of the Internet. Evidence presented in this submission shows that far from falling
behind its competitors in the ability to accrue the benefits of an information economy, New
Zealand is amongst the world leaders when its performance is measured in the volume of
usage, the types of applications routinely used, and the welfare that has already be
demonstrated to have accrued through the extensive use of customer-focused e-commerce
applications. The country leads the world in the number of Internet users per 100, and
exhibits very high levels of use of all of the technologies associated with the use of the
Internet for electronic commerce. Its performance in these statistics places it many times
higher than some of the leading OECD broadband uptake countries.
This evidence of
comprehensive performance illustrates how sole reliance upon an inappropriate proxy can
conceal important information relevant to policy making, resulting in policy interventions that
may be ill-founded.
3.
Low Uptake Must Be Considered Relative to Applications and Substitutes
If there is a demonstrated ‘problem’ in New Zealand’s broadband uptake statistics, the
evidence suggests it pertains to uptake of the technology by residential users. As residential
usage is highly dominated by the use of leisure and entertainment activities, and the projected
uses for the very high Internet speeds indicated as ‘necessary’ in a modern economy are,
given current application bases, almost exclusively residential entertainment-related (audio
and video streaming and gaming), it is not at all clear that the benefits of widespread uptake
of these technologies would be easily measured in GDP numbers. Furthermore, the analysis
of the economic and social benefits of widespread entertainment-based uptake must be
measured against the welfare currently being gained from all other leisure activities that
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compete with the broadband-mediated ones in New Zealand household spending. If New
Zealand’s low residential uptake is because there are substitute applications that generate
greater welfare than broadband-based ones, then the low residential uptake per se provides no
real cause for concern at this stage.
Despite the fact that its broadband infrastructures are more widely available and priced lower
than in most OECD countries, and that dial-up internet access is so widely diffused and
utilised, New Zealand exhibits low levels of broadband uptake.
This suggests that the
underlying reason for low New Zealand uptake is most likely a demand-side ‘problem’ rather
than a supply-side one. Given the apparent absence of supply-side impediments to uptake,
either the applications predicated upon the high speed and high capacity features of advanced
broadband services may not be highly valued by residential users, or that close substitutes are
available at prices that generate greater welfare for the consumers who use them than the
broadband-based alternatives.
Thus the core presumption that intervention in the telecommunications markets is essential to
maintain or improve New Zealand’s economic performance lacks sound theoretical or
empirical justification.
4.
Incorrect Claims that Unbundling Increases Broadband Uptake
Even if there is some merit in pursuing increases in broadband uptake, the claims made by the
Stocktake authors that mechanisms that increase competitor entry into the local loop market
are strongly correlated with higher levels of broadband uptake are not only unfounded but
demonstrably false. The authors present analysis by Network Strategies that they claim as
evidence that New Zealand’s low broadband uptake is the consequence of an absence of
competition on the local loop, and cite European Regulator Group data that they claim shows
recent increases in unbundling have generated even greater increases in broadband uptake.
No substance can be found for either of these claims in the data presented.
The methodology employed in coming to these ‘conclusions’ is unscientific, as it is based
upon comparisons using ordinal ranks rather than cardinal measures. Subjecting the data used
by the authors to some very elementary statistical analyses reveals that the authors have
rejected as explanations for New Zealand’s relative broadband uptake ranking all of
characteristics that appear to have the greatest explanatory power, based upon the cardinal
measures of both the relevant characteristics and broadband uptake across the OECD.
Verifying these findings against the body of empirical and theoretical literature where the
preliminary findings have been tested with a great deal more statistical rigour than in this
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submission confirms that the statistical analyses herein, rather than the conclusions of the
Stocktake authors and their advisers, offer the most likely explanations for New Zealand’s
comparatively low uptake. That neither the Stocktake authors nor their contracted advisers
subjected their conclusions to such simple verification processes suggests the utilisation of a
that has resulted in erroneous conclusions becoming the underlying justifications for the
unbundling proposals.
The errors in judgement that this poor research process invokes are substantial. The most
important determinants of the differences between OECD countries’ broadband uptakes,
demonstrated both theoretically and empirically in the literature and in this submission, are
(in descending order of significance) GDP per capita, population density and urbanisation
factors.
Whilst competition has some effect, it is subordinate to these other factors.
Furthermore, it is competition between infrastructures that is correlated with broadband
uptake (Figure ii). Competition between providers on an incumbent’s infrastructure appears
to have no consistent statistically significant effect, either positive or negative, upon
broadband uptake. Indeed, the empirical models in this submission suggest that the effect
upon broadband uptake from changes in market share will be at best very marginal. Using
these models, an increase in the market share of broadband lines sold by Telecom’s
competitors to 50% would be sufficient to raise New Zealand only to 19th place in the OECD
(one behind Australia). Moreover, in the extremely unlikely case of all lines being sold by
competitors, New Zealand would at be ranked only 9th in the OECD – outside of the top
quartile to which the policy-makers aspire.
Figure ii
OECD Non-DSL Market Share and Broadband Uptake
Broadmand Penetration per 100
30.0
y = -113.2x 2 + 84.012x + 2.295
R2 = 0.4657
25.0
20.0
15.0
10.0
5.0
0.0
0%
10%
20%
30%
40%
50%
60%
70%
80%
Non-DSL Market Share %
Furthermore, the ‘evidence’ cited by the Stocktake authors from the EU, which is the basis of
their claim that the evidence of unbundling’s effect is increasing as more unbundled lines are
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sold shows, if anything, a slight negative, but still statistically insignificant effect of
unbundling on DSL uptake (Figure iii). That the authors can cite such clearly inconclusive
evidence as their principal justification for intervening in the market to increase broadband
uptake via unbundling is astounding. That such a clearly incorrect set of conclusions could be
arrived at from the data presented is directly attributable to the unscientific analysis process
taken and the failure to subject the conclusions to confirmation testing. The shortcomings in
the official analysis process and the inconclusiveness of any empirical evidence that
unbundling increases broadband uptake provide substantial reason to reconsider the efficacy
of proceeding with the proposals, as it is highly unlikely that they will lead to increases in
New Zealand’s relative broadband uptake of the magnitude expected by the revised Digital
Strategy.
Figure iii
ERG New DSL Entrant Market Share and DSL Uptake
DSL Penetration per 100 Population
20
18
16
14
12
10
y = -0.0238x + 8.1417
R2 = 0.01
8
6
4
2
0
0
20
40
60
80
100
120
ERG DSL New Entrant Market Share, September 2005
5.
No Evidence that Unbundling Increases Broadband Infrastructure Investment
Whilst the authors claim that unbundling will stimulate additional investment in the sector,
they offer no empirical evidence to suggest that more investment will increase efficiency.
Their ‘evidence’ of under-investment is predicated solely upon the range of products
available, and a vague indication of a lack of the same range of high-speed products
compared to those provided in other markets. The absence of a detailed analysis of existing
and substitute investments means that there is no empirical test provided of whether increases
in the quantity of investment in broadband infrastructure will lead to increases in total welfare
relative to the counterfactual. If investment in broadband infrastructure as induced by
regulation is more expensive than the substitutes, then total welfare will decrease.
To base
such an important, industry-changing decision upon an analysis that makes no attempt to
address these issues would appear to be a highly risky, potentially unwise, action.
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Even if unbundling is adopted, there is no compelling theoretical or empirical evidence that
the intervention will actually achieve higher investment levels in total.
In this respect as
well, the authors have failed to subject their assumptions to a test of consistency with the
literature. The authors appear to have relied upon unsubstantiated evidence from OECD
officials that there is no negative effect upon investment levels, despite unequivocal empirical
evidence of reductions in investment under some circumstances (e.g. prices lower than cost in
the United States) and evidence from a published paper by one of their advisers (Cave, 2006)
that the ability to stimulate increased investment in an unbundled environment is critically
dependent upon the ways in which the market is analysed ex ante and the incentives provided
to entrants, both relative to the incumbent and relative to each other.
6.
Incomplete Analysis of the New Zealand Investment Patterns
The authors also appear to have utilised a flawed analytical methodology when analysing
New Zealand’s historic investment patterns in the broadband market. Their findings of an
investment ‘problem’ that can be corrected only by regulatory intervention are therefore
questionable.
The authors’ analysis of historic investment patterns is selective, as it measures only dollars
of historic telecommunications investment by Telecom, rather than including the historic
investments of all parties in the wider information transfer market, the timing of their
respective investments, and the strategic interactions of the parties and how this might have
affected historic patterns. By confining their analysis so narrowly, the authors do not identify
that New Zealand was an early entrant in the broadband market, that the Telecom ADSL
products were one of the very first of this technology made commercially available in the
OECD, were of extremely high quality relative to those of other entrants, widely available,
and low-priced. Therefore, the authors do not acknowledge that New Zealand was, until
around 2002, one of the world leaders in broadband market supply. By concentrating solely
upon investments, the authors have also failed to identify the strategic interactions of the
incumbent, new entrants and regulation in the development of the New Zealand broadband
market.
In particular, they overlook the role that new entrants providing broadband
technologies on other infrastructure platforms have had in providing competitive disciplines
upon Telecom, even though their market share is small. This has occurred principally due to
New Zealand regulatory characteristics and political expectations – namely the continuation
of universal pricing and unmetered calling provision obligations upon Telecom.
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The Stocktake analysis is also incomplete in that it presumes the only relevant participants in
the broadband service provision ‘value chain’ are providers of access services to end
consumers. This over-narrow frame results in pricing mechanisms, principally the use of data
data caps, which they claim are compromising the broadband experience of consumers and
thereby constraining uptake, being attributed to strategic choices made by access providers
principally Telecom. However, market analysis reveals that data caps are charged by all
providers, irrespective of the technology platform upon which the broadband information
exchange is supplied. These caps are a consequence of the high volumes of traffic that New
Zealanders source from offshore, which must pass via the Southern Cross cable. As the
Southern Cross cable owners have market power in the offshore data transfer markets, all
New Zealand broadband access suppliers are obliged to utilise their products. The caps apply
principally to information volume sourced offshore. Unbundling local access will have no
effect upon the need for all access suppliers to recover offshore transport costs in their
customer charges, so are impotent to address the perceived ‘problem’ of data caps.
By failing to investigate the pre-2002 strategic interactions, the authors also fail to address
why, up to 2002, New Zealand was a world leader in the supply of such services, whereas any
slippage relative to these benchmarks appears to have occurred only post 2002. Thus, they
overlook the very credible alternative hypothesis that New Zealand’s apparent relative
stagnation in product variety and vibrant inter-platform competition post 2002 might be
attributable not to a change in the competitive circumstances associated with Telecom and its
broadband market competitors, but to a change in the regulatory environment. There is
substantial theoretical and empirical evidence that would support a contention that regulatory
uncertainty post 2002 has been responsible for many of the changes in observed investment
patterns and participant strategic interaction.
It would appear to be highly risky to proceed with the unbundling decision without further,
more detailed analysis to determine the real extent, if any, of an investment problem, and the
underlying cause, if a problem is deemed to exist.
7.
Unbundling Regulations as Proposed Inconsistent with ‘Best Practice’
Even if, after further investigation, it is decided to proceed with unbundling, the regulations as
they are proposed vary considerably from the international ‘best practice’ that the Stocktake
authors claim they wish to pursue. Firstly, the provisions granting the Minister greater ability
to direct the Commission, and that require the Commission to take account of Government
economic policy, take the New Zealand regulatory environment further away from the ideal
articulated by the ITU that regulators be as far distanced from politicians and political
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processes as possible. These changes appear to grant the Minister more, rather than less,
influence in the activities of the Commissioner, so are contrary to the intent of the ITU ideals.
Secondly, it must be questioned whether regulatory harmony with other countries in respect
of unbundling is wise, given that other countries, notably the USA, the first country to
introduce unbundling, are beginning to move away from such regulations. Whilst unbundling
might have had definable positive benefits in a fully diffused voice telephony market, and
most of its adherents introduced it in this context when privatising incumbent
telecommunications companies, and before DSL was commercially available, its benefits in
broadband markets are still highly contentious and unproven.
Simply because, as a
consequence of history or fashion, some nations have such regulations in place is not a
sufficiently compelling justification for adopting such regulations without other substantiated
benefits being quantified relative to the quantified outcomes of the status quo. As neither new
nor status quo benefits have been quantified, it would be very risky to proceed simply on the
basis of pursuit of international regulatory harmony. Indeed, New Zealand has already
benefited from its regulatory differentiation in the past, when it was largely by-passed by the
consequences of the ‘dot.com crash’.
Thirdly, the regulations as proposed are at considerable variance to the requirements cited by
Cave (2006) as necessary if unbundling is to be pursued in order to address perceived
investment ‘problems’. The analysis undertaken has been insufficient to identify which
elements should be subject to investment incentives, whether these should be universal or
targeted, and whether obligations to unbundle infrastructure elements should be confined to
Telecom or expanded to include other participants with proprietary infrastructures. Rather, it
appears that the starting assumptions for the Stocktake are that, without any confirming
empirical analysis, Telecom’s local loop is a natural monopoly in all circumstances, and that
it is not efficient to duplicate it.
This is demonstrably incorrect, given that duplicate
infrastructure investments have been made already in many locations. Cave warns that costly
consequences will ensue if the ladder of investment is applied incorrectly as a consequence of
the initial analysis being incomplete or inaccurate.
Therefore, it would appear to be very risky to proceed with a set of regulations that obliges
Telecom, but not other infrastructure owners, to open their networks, that use a single
averaged price based upon TSLRIC methodology rather than customised prices to provide
incentives to each entrant to climb according to its own past investments and regulatory
targets, and that rather than aiming to remove unbundling as an incentive to induce entrants to
invest in their own networks, actually remove sunset clauses and thereby appear to set up
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unbundling as a long-term investment strategy for entrants rather than as a ‘leg up into
infrastructure competition’. As it stands, it appears highly unlikely that the terms in the Bill
will lead to successful scaling of the ‘ladder of investment’. Rather, they appear more
consistent with entrenching investment on Telecom’s existing networks as the economically
most desirable strategy for both new entrants and existing infrastructure owners. Thus, it is
unlikely they will lead to substantial additional investment, relative to the counterfactual of
lightly-regulated vibrant inter-platform competition that prevailed pre-2002.
Fourthly, the timing of the proposals, that see unbundling introduced before the issues of how
they will be affected by the existing geographical averaging and universal pricing regulations,
enshrined in the Kiwi Share/TSO are addressed, introduces substantial additional complexity
and distortions into the market. The Kiwi Share/TSO obligations have already had distorting
effects on investment patterns. If unbundling does result in new investment, even more
distortions are likely to occur if their potential to distort is not addressed. It would appear
unwise to encourage potential new entrants to invest on the basis of artificially high urban
prices, or an inappropriate TSO obligation based upon historic market shares and prices rather
than future costs and prices, and then subsequently alter the terms under which prices can be
set, potentially leaving them with unviable business cases and stranded assets.
It is also of significant concern that the Stocktake authors suggest that geographically
averaged prices be retained, and Telecom be constrained from lowering its prices in low-cost
areas in order to artificially advantage entrants. If prices are de-averaged for all parties before
the introduction of unbundling, and all prices charged are true reflections of cost, then there
will be no need for any costly interventions such as redistribution under the TSO, or even
more concerning, a belief that there ought to be harsher obligations for Telecom than apply
under the Commerce Act to any other dominant market participant facing competition from
new entrants.
Conclusion
As an academic practitioner, using scientific methodologies, I can find no compelling
evidence in the international body of theoretical or empirical literature and my own
theoretical and empirical analyses that would support the degree of faith the Stocktake authors
and their advisers place in the proposed policies to achieve the articulated objectives. I
strongly submit that these methodologies show that the analysis the authors have provided for
your consideration is unscientific, cursory in its use of the body of literature available on the
subject, at times contradictory and inconsistent, occasionally factually incorrect and possibly
even methodologically biased towards supporting a finding of competition ‘problems’ in
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respect of a single company. I submit that this result shows a need for caution in using their
analysis as the sole basis for such an important policy decision.
I take this opportunity to thank you for considering this submission. It is my considered view
that the substantial “reasonable doubt” raised by this submission about the likelihood of the
proposed legislation in its current form being unequivocally positive for New Zealand leaves
the case for proceeding “not proven”.
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Contents
EXECUTIVE SUMMARY ......................................................................................................................3
PREAMBLE ..........................................................................................................................................19
THE UNBUNDLING PROPOSAL RATIONALE...............................................................................21
1.
A COMPETITION ‘PROBLEM’ ......................................................................................................21
2.
RESOLVABLE ONLY BY REGULATORY INTERVENTION ...............................................................23
3.
IN ORDER TO:.............................................................................................................................23
(a)
Meet Digital Strategy Targets .........................................................................................23
(b)
Address Investment ‘Problems’ ........................................................................................24
(c)
Conform with OECD Regulatory Conventions.................................................................25
IDENTIFYING THE VARIANCES.....................................................................................................26
1.
IS BROADBAND UPTAKE A DRIVER OF GDP GROWTH? .............................................................26
2.
DOES UNBUNDLING DRIVE BROADBAND UPTAKE? ...................................................................27
3.
DOES LLU INCREASE TOTAL INVESTMENT IN BROADBAND INFRASTRUCTURE? .......................28
4.
IS THERE A NEW ZEALAND INVESTMENT ‘PROBLEM’ ................................................................29
5.
HOW WILL THE NEW ZEALAND UNBUNDLING PROPOSALS BE APPLIED? ..................................29
VARIANCE 1.
BROADBAND UPTAKE AND GDP GROWTH ...................................................31
1.1
ICTS, PRODUCTIVITY AND MEASURED OUTPUT PERFORMANCE ...........................................33
1.2
THE PLACE OF BROADBAND IN THE ICT MIX ........................................................................34
1.2.1
Broadband is the Internet Frontier Technology ...............................................................35
1.2.2
Diffusion of the Frontier Technology ...............................................................................36
1.3
DIFFUSION METRICS ECONOMIC PERFORMANCE MEASURES AND TARGETS .........................37
1.3.1
The Relative Value of Speed and Capacity .......................................................................38
1.3.2
Investment in Broadband Drives Economic Growth? ......................................................39
1.4
ORDINAL RANKS OR CARDINAL METRICS? ...........................................................................41
1.5
ALTERNATIVE VIEWS ............................................................................................................43
1.5.1
Is New Zealand’s OECD Position (22) in Broadband Uptake a ‘Problem’?...................45
1.5.2
Consistency with GDP per Capita....................................................................................46
1.5.3
High Levels of Internet Uptake and Usage.......................................................................48
1.5.3.1
World-Leading Internet Uptake ............................................................................................. 48
1.5.3.2
High Levels of Hours per Dial-Up Account per Month.......................................................... 49
1.5.3.3
Application Bases................................................................................................................... 50
1.5.3.4
Secure Servers per Capita...................................................................................................... 50
1.5.3.5
Other Commercial Infrastructure .......................................................................................... 51
1.5.4
1.6
Output Statistics................................................................................................................52
WHAT IS THE NEW ZEALAND ‘PROBLEM’? ............................................................................53
1.6.1
How ‘Valued’ are Broadband Features? .........................................................................53
1.6.1.1
Connection Speed................................................................................................................... 54
1.6.1.2
Connection Capacity.............................................................................................................. 54
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1.6.1.3
Future Applications................................................................................................................ 56
1.6.1.4
Different Policies for Different Sectors.................................................................................. 57
1.7
SUMMARY .............................................................................................................................57
VARIANCE 2.
2.1
DRIVERS AND DETERMINANTS OF BROADBAND UPTAKE......................64
THE NETWORK STRATEGIES COMPETITION ‘DIAGNOSIS’ METHODOLOGY ............................66
2.1.1
Rejection of Country Characteristics ...............................................................................66
2.1.2
Conditional Rejection of Entry Level Broadband Market Prices .....................................67
2.1.3
Acceptance of Competitive Entry Explanation .................................................................68
2.1.4
Unbundling Characteristics and Methodological Inconsistency......................................69
2.1.5
Stocktake Authors’ Acceptance of Network Strategies Findings ......................................70
2.2
REGRESSIONS USING NETWORK STRATEGIES AND STOCKTAKE DATA ..................................70
2.2.1
GDP per Capita................................................................................................................70
2.2.2
Population Distribution ....................................................................................................71
2.2.3
New Entrant Market Share ...............................................................................................73
2.2.4
Comparison with European Regulator Group Data.........................................................76
2.3
CONFIRMATION OF EXPLORATORY DATA FINDINGS VIA LITERATURE REVIEW .....................80
2.3.1
Multivariate Analyses .......................................................................................................81
2.3.1.1
Geography, Income and Inter-Platform Competition Significant .......................................... 82
2.3.1.2
But Little Evidence that Unbundling is Significant ................................................................ 82
2.3.1.3
Unbundling is Sometimes Negatively Correlated with Broadband Uptake............................ 83
2.3.2
Demand-Side Explanations and the New Zealand Data...................................................84
2.3.2.1
Prices and Availability of Substitute Internet Connections .................................................... 85
2.3.2.2
Application Bases................................................................................................................... 87
2.3.2.3
The Business Adoption Effect................................................................................................. 89
2.4
SUMMARY .............................................................................................................................90
VARIANCE 3: UNBUNDLING AND INVESTMENT IN BROADBAND INFRASTRUCTURE ...92
3.1
UNBUNDLING HISTORY AND BROADBAND TECHNOLOGIES ...................................................94
3.1.1
Convergence and Competition .........................................................................................94
3.1.2
Mobile Competition and Diffusion ...................................................................................96
3.1.3
Why Persist With Industry-Specific Regulation?..............................................................96
3.2
THEORIES OF UNBUNDLING AND INVESTMENT ......................................................................97
3.2.1
The ‘Ladder of Investment’...............................................................................................98
3.2.1.1
Application in Canada ........................................................................................................... 99
3.2.1.2
Application in Germany ....................................................................................................... 101
3.2.1.3
Application in the United States........................................................................................... 103
3.2.2
3.3
Uncertainty, Options and Investment Incentive Depression...........................................104
3.2.2.1
Uncertainty and Investment in New Zealand ....................................................................... 107
3.2.2.2
Investment in Telecommunications as an Alternative to Non-Telco Investment................... 108
LONG-TERM DYNAMIC EFFICIENCY EFFECTS ......................................................................109
VARIANCE 4.
4.1
THE NEW ZEALAND INVESTMENT ‘PROBLEM’ ........................................110
BACKGROUND: NEW ZEALAND TELECOMMUNICATIONS MARKETS ....................................112
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4.2
INTERNATIONAL COMPARISON OF NEW ZEALAND INVESTMENT HISTORY ..........................114
4.2.1
Investment as a Percentage of GDP and Access Channels ............................................115
4.2.3
Comparison with Small Early Digitisers/NGN Investors ...............................................117
4.2.4
Investment as a Percentage of Revenues ........................................................................118
4.2.5
Revenues .........................................................................................................................118
4.3
NEW ZEALAND INFORMATION EXCHANGE MARKETS PRE-2003..........................................120
4.3.1
Telecom an OECD Leader in ADSL Deployment...........................................................122
4.3.2
Product with ‘Leading Edge’ Speed ...............................................................................122
4.3.3
At Internationally Low Prices.........................................................................................122
4.3.3.1
Data Caps and Local Access Networks................................................................................ 123
4.3.3.2
Local Access Competition Cannot Reduce Prices for International Traffic......................... 124
4.3.4
Rapid Rollout, Wide Availability of DSL ........................................................................124
4.3.5
Inconsistent with the ‘Monopoly Power’ Investment Thesis...........................................125
4.3.6
Other Broadband Investments Pre 2002 ........................................................................125
4.3.6.1
Telecom the 3rd Broadband Technology to Market .............................................................. 125
4.3.6.3
Cable Entry in 1999 ............................................................................................................. 126
4.3.6.4
Fixed Wireless Entry in 2001 ............................................................................................... 126
4.3.6.5 Mobile Broadband....................................................................................................................... 127
4.3.6.6
Wireless Hotspots................................................................................................................. 127
4.3.6.7
Other Fibre providers .......................................................................................................... 128
4.4
COMPETITION IN THE NEW ZEALAND BROADBAND MARKET POST 2003 ............................128
4.4.1
No Evidence of An Infrastructure Supply Problem.........................................................128
4.4.2
But Regulatory Uncertainty Implicated in a Change in Competitive Interaction...........129
4.4.2
Competition in Infrastructure or Customer Markets? ....................................................130
4.4.3
The Incumbent Must Be Allowed to Compete for Customers as Well.............................131
4.5
ANALYTICAL WEAKNESSES IN THE STOCKTAKE APPROACH ...............................................132
VARIANCE 5.
5.1
NZ APPLICATION OF THE UNBUNDLING PROPOSALS ...........................133
REGULATORY INTERNATIONAL BEST PRACTICE ..................................................................133
5.1.1
Inter-Platform Competition is Regulatory First-Best .....................................................133
5.1.2
LLU a Second-best in the Absence of Vibrant Inter-Platform Competition ...................134
5.1.3
Regulatory ‘Fashion’ or Empirically Robust Policy? ....................................................134
5.1.4
Policy Variety and Sustainable National Competitive Advantage..................................135
5.1.5
Politically Independent Regulatory ‘Best Practice’ as Advocated by the ITU ...............136
5.1.6
Clauses 9 and 31 Reduce Independence of the Commission .........................................136
5.2
“BEST PRACTICE’ ‘LADDER OF INVESTMENT’ APPLICATION ...............................................136
5.2.1
First, Establish the Natural Monopoly Elements............................................................137
5.2.1.1
But No Principled Analysis Undertaken in the Stocktake..................................................... 137
5.2.1.2
Motivated by Infrastructure Unbundling or Customer Unbundling Objectives? ................. 139
5.2.2
Second, Populate the “Ladder” and Design Customised Climbing Incentives ..............139
5.2.2.1
Yet the Bill Sets Intervention Criteria Using Telecom Network Characteristics.................. 140
5.2.2.2
TSLRIC Prices Decline over Time, Disincentivising Investment.......................................... 141
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5.2.2.3
Removal of Section 65 Sunset Clause................................................................................... 141
5.2.2.5
Entrenchment of Current Positions and Lower Investment.................................................. 142
5.3
UNBUNDLING AND THE TSO................................................................................................142
5.3.1
Geographic Averaging and ‘Predatory Pricing’ ............................................................143
5.3.2
Timing of Geographic ‘De-averaging’ ...........................................................................144
CONCLUSION ....................................................................................................................................146
REFERENCES....................................................................................................................................148
APPENDIX 1.
UNBUNDLING TELECOMMUNICATIONS HISTORY ..................................153
APPENDIX 2.
UNIVERSAL PRICING AND COMPETITIVE ENTRY....................................160
List of Figures
FIGURE 1.1
A MODEL OF WELFARE GROWTH FROM INFRASTRUCTURE INVESTMENT .....................44
FIGURE 1.2
GDP PER CAPITA AND ICTS, 2004................................................................................45
FIGURE 1.3
OECD BROADBAND PER CAPITA AND GDP PER CAPITA, DECEMBER 2005.................47
FIGURE 1.4
NEW ZEALAND DIAL-UP MINUTES PER ACCOUNT ........................................................49
FIGURE 1.5
SHARE OF ICT VALUE-ADDED IN BUSINESS SECTOR VALUE-ADDED, 1995 AND 2001 53
FIGURE 2.1
BROADBAND UPTAKE PER CAPITA AND GDP PER CAPITA – LINEAR RELATIONSHIP ....71
FIGURE 2.2
BROADBAND UPTAKE AND URBANISATION ..................................................................72
FIGURE 2.3
NETWORK STRATEGIES: NEW ENTRANT MARKET SHARE AND BROADBAND UPTAKE .74
FIGURE 2.4
NETWORK STRATEGIES NEW ENTRANT MARKET SHARE: QUADRATIC CURVE ............75
FIGURE 2.5
OECD NON-DSL MARKET SHARE AND BROADBAND UPTAKE ....................................75
FIGURE 2.6
ERG NEW ENTRANT MARKET SHARE AND BROADBAND UPTAKE ...............................76
FIGURE 2.7
ERG NEW ENTRANT MARKET SHARE AND BROADBAND UPTAKE: QUADRATIC ..........77
FIGURE 2.8
ERG NEW DSL ENTRANT MARKET SHARE AND DSL UPTAKE ....................................77
FIGURE 2.9
CRITERION BROADBAND PENETRATION AND PLATFORM COMPETITION, 2003 .............79
FIGURE 2.10
CRITERION BROADBAND PENETRATION AND NON-INCUMBENT DSL ACCESS, 2003 ...79
FIGURE 2.11
CRITERION TAKE-UP OF LLU/LINE SHARING/BITSTREAM/RESALE, 2003 ....................79
FIGURE 3.1
UNITED STATES LINE OWNERSHIP, UNBUNDLING AND RESALE 1997-2002 ...............103
FIGURE 4.1
INVESTMENT PER CAPITA 1997-2003..........................................................................115
FIGURE 4.2
INVESTMENT PER ACCESS CHANNEL 1997-2003.........................................................116
FIGURE 4.3
INVESTMENT PER ACCESS CHANNEL: EARLY DIGITISERS ...........................................117
FIGURE 4.4
INVESTMENT AS A PERCENTAGE OF REVENUES ..........................................................118
FIGURE 4.5
NEW ZEALAND TELEPHONY NETWORK TRAFFIC 1996-2003 ......................................119
FIGURE 4.6
NEW ZEALAND PER CONNECTION TELECOMMUNICATIONS UTILISATION 1996-2002.120
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List of Tables
TABLE 1.1
COUNTRIES WITH THE HIGHEST INTERNET PENETRATION RATE ......................................59
TABLE 1.2
OECD SECURE SERVERS PER CAPITA, 1998-2004............................................................60
TABLE 1.3
OECD COUNTRIES: REFERENCES TO SECURE SERVERS, 2002-4 ......................................61
TABLE 1.4
INTERNET ACTIVITY DATA, AUSTRALIA: 2003-5 .............................................................62
TABLE 2.1
PAY TELEVISION SERVICES IN THE OECD ........................................................................91
TABLE 3.1
COMPETITOR INVESTMENT IN GERMANY: 1998-2002 .....................................................102
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Preamble
The Telecommunications Amendment Bill (the Bill) provides for legislation to introduce in
the New Zealand market a range of regulatory measures, including Local Loop Unbundling
(LLU), expanded provision of existing Bitstream offers, and accounting separation of the
incumbent, Telecom New Zealand Ltd (Telecom). The decision to proceed with this Bill was
made by Cabinet following the preparation of a ‘stocktake’ of the Telecommunications sector
led by officials from the Ministry of Economic Development (MED) on the request of the
Telecommunications Minister David Cunliffe (the Minister). The decision was announced on
May 3 2006. The full text of the ‘stocktake’ report and the documents supporting the
recommendations made in it were subsequently made publicly available by the Ministry of
Economic Development1.
The purpose of this submission is to provide a principled and rigorous independent academic
critique of the key assumptions and conclusions upon which the proposed amendments
relating to LLU and expanded bitstream services (hereinafter referred to jointly as ‘the
unbundling proposals’) are based.
The principal documents used for this analysis are the
Cabinet Policy Committee Minute of Decision 06/79, the associated Telecommunications
Stocktake background paper (hereafter referred to as the Stocktake), and the supporting
papers authored by MED and a variety of consultants (for a full list, see Stocktake, Annex 1).
The views expressed and policy recommendations proposed in the Stocktake are presumed to
be the conclusions of the Minister and policy advisers formed as a consequence of
undertaking their own analysis, and informed by the advice received from consultants,
principally Network Strategies and Azimuth.
The motivation to undertake this analysis arises as a consequence of the considerable variance
between many of the views and conclusions expressed in the Stocktake, and those formed by
the author over an extended period as an analyst of the New Zealand and world broadband
markets. A particular concern attends the extent to which professionally and academically
unsound methodologies have been employed in formulating many of the conclusions arrived
at of the actual state of the New Zealand telecommunications and broadband markets, and in
assessing the likelihood of any of the regulatory mechanisms proposed in this Bill succeeding
in addressing any real, or perceived ‘problems’ that may, or may not have been, identified.
These issues of methodological concern stem from the lack of evidence that the authors of the
Stocktake and underlying reports have consulted the very large body of peer-reviewed
1
http://www.med.govt.nz/templates/ContentTopicSummary____20541.aspx.
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academic literature that exists on the nature of broadband markets in order to inform their
analysis and recommendations, and the unscientific nature of many of the empirical analyses
conducted in the course of the ‘Stocktake’ exercise. A very real risk exists that crucially
important decisions about the future of the New Zealand broadband market will be made on
the basis of an analysis that is materially flawed both in process and content.
The submission, therefore, will systematically identify the nature of the chosen unbundling
proposals, and the key evidence presented in the Stocktake and supporting documents upon
which these recommendations have been based. The supporting evidence presented will then
be subjected to a critical analysis based upon the body of relevant academic literature, and the
empirical analyses subjected to checks on their statistical robustness, plausibility and
consistency, both individually and in conjunction with a wide variety of other metrics that
have been shown in the literature to have considerable explanatory effect in respect of
observed behaviour and economic performance in broadband markets worldwide.
This
analysis will illustrate that there is a very large amount of uncertainty about both the accuracy
of the stocktake ‘diagnosis’ of the nature and cause of the ‘problems’ in the New Zealand
broadband market, and even greater levels of uncertainty about the likelihood of the
Minister’s longer-term aspirations for the sector being achieved if the unbundling proposal
‘remedies’ are implemented as they are presented in the Bill.
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The Unbundling Proposal Rationale
The ascribed purpose of the unbundling proposals2 is to “improve the New Zealand
telecommunications regime” (Stocktake, para 1)3 and to “ensure that the telecommunications
sector becomes more competitive and that we achieve faster broadband uptake in line with
our competitors” (para 3). This is deemed necessary because “there is a significant gap
between New Zealand and the leading OECD countries in terms of broadband performance”,
reflected by the finding that “in general, New Zealand remains at the bottom one-third of the
OECD countries across a range of telecommunications service pricing and broadband take-up
indicators” (para 4). In the assessment of the authors, “broadband services being offered in
New Zealand are not as good as those available in competing countries and penetration is
correspondingly low” (para 89).
Whilst it is acknowledged in passing in that there are a number of factors contributing to New
Zealand’s poor performance, namely low GDP per capita and demographic and geographic
constraints, such as a small population, low national population density, a widely distributed
population and a small market for investment relative to other OECD countries, these are
offered principally as explanations for there being “negligible alternate cable infrastructure”
(para 42), rather than as an explanation of why New Zealand telecommunications investment
and uptake patterns may have differed historically from those of other OECD countries
exhibiting different economic, geographic and demographic characteristics. Moreover, it is
claimed that these characteristics are “insufficient to explain our relative position” (para 42).
1.
A Competition ‘Problem’
Rather, the Stocktake authors have concluded that “a key characteristic of the best performing
OECD countries is the vigour of competition in their telecommunications markets, combined
with regulatory regimes which pro-actively encourage competition” (Stocktake, para 7).
Thus, they conclude that the “key reason for (NZ’s) poor performance is the lack of effective
competition in key market segments” (Stocktake, para 34 – emphasis in the original), and
that this can only be addressed by regulatory intervention (“while OECD upper quartile
performance should remain our aspiration, international benchmarking suggests that this will
not be achievable until effective competition is established in the market following regulatory
changes” – para 25). This conclusion prevails, even though the authors concede that the New
3
From this point onwards, all references to the Stocktake report will simply refer to the relevant paragraph).
8/11/2006
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Zealand economic, geographic and demographic characteristics of New Zealand make
“competitive conditions more difficult to achieve” (para 42).
The focus of the proposals on the “telecommunications markets” and services delivered over
the copper loop, to the exclusion of other technology platforms capable of delivering
broadband services appears to be justified by the observation of the current small market
share of these alternatives (para 42). Whilst it is acknowledged that telecommunications
technologies are evolving rapidly and that traditional telephony services will be inevitably
replaced by internet-based services (para 42), the effect mobile (paras 46-48) and wireless
(para 49) broadband services upon competition is deemed negligible because it is “unlikely
that these technologies will match the speed and unit costs of fixed network technologies”
(para 47). The possible future potential of WiMax is noted (para 49).
Despite the authors’ apparent lack of confidence in the ability of alternative platforms to
influence competition in the New Zealand context, they propose unbundling as a tool
enabling new entrants to ‘climb the ladder of investment’, with the objective of ultimately
owning their own infrastructures with which they will compete with the incumbent (para 99).
Whilst the links between unbundling on copper and facilitating investment in non-copper
technologies in the “coherent package” of policy options proposed (paras 89-100) are not
entirely clear, a view is expressed that “facilitating alternative investment in infrastructure” to
the extent that such inter-platform competition will provide additional competitive pressure
will require “addressing barriers to market entry” (para 80). Whilst the physical barrier to
competition on copper is assessed to be access “bottleneck” created by Telecom’s current
ownership of the relevant property rights (para 36), other barriers are deemed to exist with
respect to “the behaviour of incumbent operators (for example, geographic discrimination in
incumbent pricing)” (para 80) and “financial risks to potential investors” (para 81), which it is
assessed will not be overcome without further regulatory or government intervention.
Suggested interventions include “revising laws relating to price discrimination as applied to
the telecommunications sector”, “ensuring Telecom maintains prices across large geographic
areas which the entrant could more easily compete against in higher-value, smaller
geographic areas” (para 81) and government, local government and community-owned
organisations “seeding entrants’ investment in order to reduce the inherent risks they face”
(para 81).
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2.
Resolvable Only by Regulatory Intervention
The unbundling proposals are therefore to be introduced as part of a package of interventions
(including extending the Digital Strategy Broadband Challenge fund – para 9) designed to
engineer a change to the status quo in the nature and form of competition in the copper-based
telecommunications market that has prevailed under the Telecommunications Act 2001 and
its subsequent amendments.
The assumption is that, by stimulating competition in this
market, New Zealand’s poor performance in broadband uptake will be overcome – that is, it
will “help New Zealand catch up with the leading OECD countries by promoting competition
that would speed up the provision of fast, multi-faceted broadband services” (Bill Digest, p
3). Broadband is considered “essential to support economic competitiveness and to provide
world-class information services to users” (para 89).
3.
In Order to:
(a)
Meet Digital Strategy Targets
Intervention is deemed necessary if the policy target set in the Digital Strategy4 for New
Zealand to be in the top half of the OECD for broadband take-up by 2010 and the top quartile
by 2015 (adjusted back from a top quartile by 2010 following the Stocktake exercise – para
21), is to be achieved. A top quartile placing out of the 30 OECD countries equates to a rank
of no less than 7th or 8th.
The OECD ranking in broadband uptake is the overriding
performance metric to be used in assessing performance against the broader Digital Strategy
goal that New Zealand be “a world leader at using information and communications
technology (ICT) for economic, social and cultural gain, and to ensure that all New
Zealanders can access the benefits that ICT can bring” (Stocktake, para 19). The weighting
given to this proxy for measuring benefit gained from using all ICTs, to the exclusion of all
other proxies that might inform on this performance, is justified by the authors’ contention
that “broadband uptake contributes to increasing GDP” (Stocktake, para 20).
The need for alterations to the existing regulatory interventions (principally wholesale and
limited bitstream offers arising from the 2003 review of LLU by the Telecommunications
Commissioner) in order to meet either the original or revised Digital Strategy targets is
deemed necessary because the existing interventions have been adjudged to have failed to
meet targets set for these policies. Even though entry level broadband products are “broadly
comparable in terms of price to other OECD countries” (para 27) and there is considerable
evidence that uptake of entry level products has accelerated strongly since the introduction of
4
http://www.digitalstrategy.govt.nz
8/11/2006
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bitstream access in 2004 (para 29), a competitive ‘problem’ exists because fewer of the new
connections were sold by competitors to Telecom than was acceptable “in the Commerce
Commission’s or the Government’s views” (para 41)5.
(b)
Address Investment ‘Problems’
The authors anticipate that the principal market response to the unbundling proposals will be
acceleration in the rate of investment in the telecommunications sector by both Telecom and
new entrants (para 11). Regulation is deemed necessary to stimulate increased investment
because the authors have concluded that lack of competition for Telecom has led to reduced
incentives for it to invest, resulting in a residential and small business user experience that is
“less compelling in terms of speed and quality with low speeds, particularly in the up-link,
and restrictive data caps” (para 23) relative to other OECD countries. The consumer view
offered is that “New Zealand users are expressing a strong desire for faster, better value
broadband services” (para 23). The evidence of under-investment is New Zealand’s low
OECD ranking (22) in telecommunications investment per capita in the period 2001-2003
(para 30), and that currently-offered Telecom product speeds range from 256kbps to 3.5Mbps
whilst faster speeds are beginning to be deployed in other OECD countries (para 27).
Higher-speed broadband services are deemed necessary to support the provision of interactive
content-based services (para 27), namely the “e-commerce, digital delivery of TV, video,
interactive and entertainment services” that are considered to be “drivers of residential and
small business uptake” in other countries (para 51). In particular, digital TV and video are
seen as “the compelling reason for rolling out fibre closer to residential users” (para 52).
Whilst the authors acknowledge that New Zealand’s relative performance in investment per
capita has improved following 2003, this is presumed to have occurred as a consequence of
“increased regulatory pressure” (para 31). Nonetheless, they observe “Telecom’s investment
in replacing its residential telephone services exchanges with Next Generation equipment has
slipped a year or more from its originally-announced plan” and that “the launch of advanced
broadband services has been similarly delayed and there has been little investment in fibre to
the cabinet to improve the broadband speed of the copper local loop” (para 32). This has
occurred even though “the Commerce Commission’s limited speed bitstream unbundling
proposal sought to maintain its incentives to quickly roll out its NGN infrastructure” (para
32).
5
Although there is now some disagreement about whether the target was unsatisfactory in the view of officials – ref (see Bryce’s
piece)
8/11/2006
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(c)
Conform with OECD Regulatory Conventions
The regulatory package proposed is further supported by the observation that “other
jurisdictions in the OECD have moved in the direction of more vigorous pro-competitive
regulatory frameworks to improve access conditions” (para 33). Specifically, unbundling is
“consistent with approaches adopted in other countries, including those leading in
broadband uptake” (para 92, emphasis in original). Consistency with the European Union
(EU) “ladder of investment” approach to unbundling is advocated, as the objective of this
approach is to incentivise new entrants to successively invest more and more in their own
equipment, with a long-term view to them ultimately owning their own platforms which they
use to compete with the incumbent (para 99).
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Identifying the Variances
1.
Is Broadband Uptake a Driver of GDP Growth?
In the first instance, it is the apparently unequivocal presentation of the direct and causal
nexus between broadband uptake and firstly GDP per capita, and secondly, superior economic
performance in an information-based economy, where the underlying assumptions and
conclusions of the Stocktake begin differing from the conclusions formed by of the author.
Quite simply, there is no conclusive evidence in the academic literature supporting a direct,
measurable causal relationship between broadband uptake in a given country and its absolute
level of, or growth rate of, GDP per capita.
Lack of academically and empirically substantiated evidence, however, has not deterred many
academics, policy-makers and, notably, management consultancies from making and
publishing a number of highly speculative projections about what the quantitative effect of the
relationship between broadband uptake and GDP might be.
In order to do so, these
forecasters must make a number of highly speculative underlying assumptions, which are
crucially important in arriving at the quantum of their projections.
In most instances
(including two of those cited by the Stocktake authors as supporting evidence for the strength
of their claims6) the authors do not state clearly what these assumptions are, thereby limiting
the confidence with which the forecasts can be applied in a variety of contexts or
circumstances.
If the underlying speculative assumptions do not materialise into actual
occurrences in the manner projected by the forecasters, the decisions made on the basis of
these forecasts are invalidated. It is widely accepted that the ‘dot.com boom’ of the 1990s
and the subsequent ‘dot.com bust’ of 2001-2 occurred largely as a consequence of many
highly speculative, and subsequently invalidated, assumptions made about the likely future
demand for bandwidth and use of Internet-mediated ICT applications. Many of these were
made by the same academics, policy-makers and management consultancies that have
subsequently published GDP growth projections based upon their more recent assumptions
surrounding application development and broadband uptake.
6
That is, the Economist Intelligence Unit survey prepared in 2006 for the HiGrowth Economic Impact Report
http://www.higrowth.co.nz/index.html, and Allen Consulting Group’s report True Broadband – exploring the economic impacts,
prepared for Ericson in 2003. Whilst the third study, by the UK’s Centre for Economic and Business Research is slightly more
transparent in its methodology, in that it proposes a band of possible productivity increases (from 0.5 to 2.5 per cent), the
corresponding translation into likely changes to GDP are specific to the UK environment, and not necessarily easily transportable
into other economies, given the different industrial structure prevailing in each country (for example, gains possible in heavy
manufacturing and financial services in the UK will be very difficult to replicate in New Zealand, given the very small
contribution of these industries to New Zealand’s overall GDP).
8/11/2006
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The first part of the submission, therefore, addresses the core assumption underpinning the
unbundling proposals – that is, that increasing broadband uptake is imperative to securing
New Zealand’s future economic prosperity in an ‘information economy’. In partial refutation
of the almost exclusive reliance upon broadband uptake as the sole proxy for actual and
potential economic performance, this section will illustrate that, by a variety of connectivity
and usage metrics, New Zealand is already at the forefront of the OECD in the use of ICTs for
measurable economic gain, and in some instances is performing many orders of magnitude
more productively than some high-profile countries conspicuous by their presence in the top
eight of the OECD with respect to broadband uptake. This section also questions the validity
of using ordinal OECD rankings rather than cardinal measures in both setting targets and
assessing relative and absolute performance against those targets.
2.
Does Unbundling Drive Broadband Uptake?
The second variance between the author and the Stocktake conclusions is that, even if there
might be some merit in pursuing a higher level of broadband uptake in New Zealand, it is far
from clear that increased competition on the local loop, be it from full unbundling, expanded
bitstream offerings, or even enhanced wholesale offers, will lead to substantial increases in
broadband uptake. The second section of the submission summarises the academic literature
about the factors which have been shown, by robust econometric modelling subjected to peer
review, to be significantly correlated to different levels of broadband uptake. Whilst this
literature proves that competition is important, the single most important factor is competition
between technology platforms (inter-platform competition) rather than competition on one
single platform (intra-platform competition). However, even then, the effect of these factors
appears to be subordinate to a variety of other factors known to be correlated with broadband
penetration, such as per capita income, population density, degree of urbanisation of the
population and the types of regulatory regimes prevailing income, are controlled for.
This section takes the data underlying the analyses presented by Network Strategies in
support of competitive restrictions in the local loop being the ‘cause’ of New Zealand’s low
broadband penetration and the reason why other countries perform more impressively, to
illustrate how the incorrect conclusions drawn by the Stocktake authors arise as a
consequence of applying an unscientific and inconsistent analytical methodology based upon
ordinal rankings rather than cardinal values. Applying a set of slightly more statistically
rigorous screening tests on the same data reveals the flaws in the Stocktake conclusions.
Moreover, using the 2005 European Regulator Group data cited in the Stocktake (para 114) as
‘evidence’ that the type of unbundling regulations promulgated in Europe have led to
8/11/2006
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increases in the uptake of broadband reveals that, rather than being correlated with higher
broadband uptake, there is a slight (but not statistically significant) negative relationship
between the proportion of DSL lines sold by competitors and broadband uptake.
3.
Does LLU Increase Total Investment in Broadband Infrastructure?
The third variance concerns the effects that unbundling rules have upon the incentives for
both incumbents and new entrants to invest in broadband infrastructure.
Section three
examines the literature on unbundling, highlighting the ways in which unbundling alters the
locus of financial risk-bearing in the telecommunications sector, and illustrates the difficulties
facing regulators in setting prices for unbundled services that adequately account for the
additional financial risks that must be borne by incumbents. Using the illustration of inflated
projections for unbundled services during the ‘dot.com boom’ of the 1990s, and the
subsequent ‘dot.com bust’ of 2001-2, this section shows that unless the prices for unbundled
elements are ‘correct’ (in that they adequately compensate the incumbent for the additional
financial risks that must be borne), and that all of the orders placed by new entrants for
facilities and services provided by the incumbent proceed through to the delivery of actual
services that are fully paid for (that is, all entrants projections are correct and all orders
fulfilled as actual purchases), incumbent shareholders carry financial risks that are outside of
their ability to control, so may be reluctant to invest in new infrastructures that are subject to
unbundling.
This section also examines the effect that unbundling can have in diverting investment that
would otherwise have been invested in competing infrastructures into investments on
telecommunications networks, to the detriment of both total investment in the wider market,
and inter-platform competition. Such analysis calls into question the efficacy of the New
Zealand regulations that constrain analysis and intervention to the ‘telecommunications’
segment of a sector where ‘convergence’ is leading to the creation of markedly different
vertically integrated competitive landscapes covering the creation, transmission, storage and
consumption of digital information. By way of illustration, this section contrasts the market
definition approaches of the United States Federal Communications Commission, where the
relevant market is deemed to be ‘information’, and the European Union, where the more
narrow ‘telecommunications’ definition prevails.
8/11/2006
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4.
Is there a New Zealand Investment ‘Problem’
Given that the preceding sections have raised concerns about both the definition of the
‘problems’ in New Zealand, and the extent to which unbundling can address them, this
section examines the state of competition in the New Zealand broadband market, as opposed
to the narrower ‘telecommunications’ market chosen for analysis by the authors of the
Stocktake.
The variance between the author and the Stocktake authors in this section
concerns the extent to which there has already been considerable investment in competing
broadband infrastructures, and the ways in which these investments have, both historically
and currently, influenced both the amount of competition in the market, and the timing of
incumbent investment. This section also argues that, in line with the findings of section three,
regulatory uncertainty, and in particular the long delays in making a binding decision about
whether or not to proceed with unbundling has of itself increased uncertainty and therefore
likely depressed the incentives for either Telecom or the owners of other platforms entrants to
make commitments to large investments on their own networks.
This section also considers in more depth whether the evidence presented of low investment
in New Zealand telecommunications networks has been as poor as suggested by the Stocktake
authors. By considering the specific economic and geographic characteristics of the New
Zealand market, the relevance of the ‘investment per capita’ metric as the appropriate one for
benchmarking is questioned. This section provides alternative evidence suggesting that the
metric chosen for comparison has resulted in a misleading picture of the true state of the New
Zealand market, thereby drawing into question the efficacy of the ‘remedies’ chosen for
possibly non-existent ‘problems’. Furthermore, this section raises the question of whether the
history of strategic interaction in the sector is consistent with the findings of a competition
‘problem’ arising from the strategic choices of infrastructure providers or whether there are
other possible explanations for observed behaviour.
5.
How Will the New Zealand Unbundling Proposals Be Applied?
The final variance between the author and the Stocktake authors concerns the extent to which,
even if there might be some validity to the claim that more competition on the local loop is
necessary, the regulations proposed might progress towards achieving the desired stimulation
towards long-term infrastructure-based competition. Whilst the ‘ladder of investment’ model
has some merit in stimulating a path towards inter-platform competition, if it is to be applied
successfully, there must be a significant amount of clarity about exactly what forms of
infrastructure investment must be stimulated, and how to provide the appropriate incentives
for each entrant to ‘climb the ladder’. If it is to be introduced in a market where there are
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participants at all stages of infrastructure ownership, and a variety of different sub-markets
with very different underlying economic, geographic and demographic characteristics, it is
not obvious that the logical application is in a universal set of regulations applying equally to
all potential market participants other than the incumbent, and in all parts of the country.
Section five, therefore, examines why the hybrid nature of the New Zealand broadband
market means that there are substantial risks associated with implementing unbundling as
proposed. In particular, there are already considerable distortions to investment incentives
associated with the Kiwi Share/TSO obligations upon Telecom that must be considered in
terms of determining how to structure the desired investment incentives.
This section
illustrates the real problems that might have already been induced by this regulatory
intervention, and explores how other countries, such as Canada, have mitigated the effects of
stimulating cost-conscious new investment. The failure to include such elements in the New
Zealand proposals differs from international ‘best practice in this respect, and therefore draws
into question the efficacy of the New Zealand proposals.
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Variance 1. Broadband Uptake and GDP Growth
The authors of the Stocktake offer as their key underlying justification for intervening in the
telecommunications market the ‘fact’ that “access to broadband services is a key enabler of
economic growth and the development of a knowledge-based economy” (para 20). Their
‘evidence’ that New Zealand is falling behind its competitors is that, using broadband
connections per capita as the measure, New Zealand is 22 out of 30 OECD nations (para 26).
‘Success’ is defined as a top quartile OECD ranking in this metric (para 26). “Slipping
behind our OECD peers” (para 18) is construed as a ‘problem’ from the authors’ inference
that the country is less able to benefit from the economic growth and development of a
knowledge-based economy that broadband is credited with enabling than its OECD peers and
competitors.
The strength of authors’ assertions about the ability of broadband to ‘enable’ economic
growth is not matched by similar strength in the conclusions drawn from the academic
literature. Furthermore, the policy recommendations of most international ‘think tanks’ by no
means provide unequivocal support for pursuing the stimulation of broadband uptake as a
policy end in itself. Despite the promises that ICTs hold for economic, social and political
development, the International Telecommunications Union (ITU) cautions that “ICTs are not
an end in themselves” (ITU, 2006: 19) and the OECD warns that “having the equipment and
networks alone is not enough to derive economic benefit” (OECD, 2003: 11).
Indeed, the
ITU (ibid.) identifies that:
“despite the potential of ICTs to be an engine for economic growth and deliver
innovative applications in government, commerce, education and health care, there is
little quantifiable proof. Evidence remains largely anecdotal and the link between
ICT and development remains vague in many ways. Whilst there is little doubt that
ICTs are generating economic, social, cultural and political changes, it is difficult to
separate their influence from those of other factors, such as governance or economic
growth”.
Furthermore, the ITU, citing Hudson (2006) cautions that “one of the dangers in the recent
enthusiasm about the role of ICTs in development is unrealistic expectations of significant
short-term impact amongst donors and policy-makers …. Much of the impact is likely to take
longer and be much more indirect” (ibid).
Rather, the ITU-sponsored World Summit on the Information Society has proposed that
“ICTs should be regarded as tools and not an end in themselves” (WSIS, DoP, A9), and as a
consequence has developed a 42-point set of core metrics for the assessment of a nation’s ICT
performance. Broadband uptake is only one of ten separate infrastructure indicators used in
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this classification, which demarcates clearly between business and residential access to and
use of the technologies. These metrics are to be used as composite indicators rather than as
policy targets, with their principal purpose being firstly to track performance across nations in
a consistent manner that will enable more reliable comparisons to be undertaken, and
secondly, to provide a reliable and comparable data base enabling principled research to be
undertaken in order to empirically test many of the speculative claims that made about the
impact of ICTs, and to develop more academically and empirically robust models of the role
that ICTs play in economic, social and political development.
The apparent lack of evidence in the Stocktake documents that the authors or their advisers
consulted any of this disconfirming literature about the impact of ICTs when forming their
basic justification for further regulatory intervention in the New Zealand telecommunications
sector is concerning. That the solitary ‘evidence’ offered to support their claims of the
importance of broadband uptake in generating economic growth are two consultants’ reports
and a market-specific UK analysis, when there is a substantial body of policy analysis placing
substantial doubt upon the efficacy of such policies suggests that there are very real risks that
the unbundling proposals may be symptoms of policy-makers having fallen victim to
Hudson’s “unrealistic expectations” about the scale, timing and likelihood of measurable
benefits accruing from the use of ICTs in general, and broadband in particular.
Nonetheless, given that the authors have made such claims, the balance of this section will
explore some of the theory underpinning the diffusion of technologies. The purpose of this
analysis is firstly to illustrate the extent of any ‘problem’ that might exist in New Zealand’s
ability to generate economic growth as a consequence of the demonstrated low broadband
uptake, and secondly to examine the potential problems that might emerge as a consequence
of making relative broadband uptake the cornerstone target of the Digital Strategy and thereby
the justification for further intervention in the telecommunications market. This section will
demonstrate that, within the context of ICTs used for economic, social and policy purposes,
broadband, as simply one form of digital information transportation, plays only a relatively
small role. As it is difficult to accurately assess the empirical impact of ICTs as a class, then
it will be even more difficult to accurately assess, or even predict, the empirical impact of one
transportation means of the digital data ‘cargo’ associated with productive use of ICTs, let
alone use its diffusion as a solitary policy target.
Notwithstanding, the available evidence, based upon a variety of metrics other than
broadband uptake, tends towards a substantially less pessimistic view of New Zealand’s
relative ability to benefit from the use of ICTs than that of the Stocktake authors’. Thus, the
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conclusion of this section is that, if the unbundling proposals are to proceed, then it must be
because of their merit in policy areas other than the pursuit of Digital Strategy targets based
solely upon broadband uptake rankings, which themselves are flawed by the inappropriate use
of technology diffusion statistics.
1.1
ICTs, Productivity and Measured Output Performance
Since the development and commercialisation of computers following World War 2, an entire
new class of goods – Information and Communication Technologies (ICTs) – has emerged.
These technologies are distinguished from other technologies by the fact that they create,
process, store, transmit and utilise digitised information (Quah, 2003). In the context of a
‘knowledge economy’, ICTs facilitate production processes that are based upon, and utilise,
information. As information is fundamental to all production processes, the potential exists
for ICTs to be utilised ubiquitously. This has led to ICTs being classified as General Purpose
Technologies (GPTs) (Helpman and Trajtenberg, 1996) – that is, technologies that are so
widespread in their uses and applications that they become deployed across all sectors of the
economy, and form the basis for an entirely new range of technologies based upon the GPT
that have the capability of generating further productivity gains over and above those arising
from the use of the GPT itself (Greenwood and Yorukoglu, 1997; Greenwood, Seshadri and
Yorukoglu, 2000).
Whilst much early speculation surrounded the likely extent of the productivity gains that
would be realised from ICTs, detecting where their effects are captured in productivity
statistics has proved to be much more difficult, as encapsulated in Robert Solow’s famous
1987 statement “you see computers everywhere but in the productivity statistics”. Whilst
many reasons have been explored for the failure of investments in ICTs to flow through to
measured outputs (for a summary, see Triplett, 1999 and Bosworth and Triplett, 2000), in
recent years, academic analysis appears to be converging upon a consensus that there is no
simple nexus between investing a dollar in ICTs and collecting a measurable return at the
output end, as might typically be expected with investment in other types of technologies
(Jarmin, 2000; Haltiwanger and Jarmin, 1999). Rather, it appears that there is a very complex
nexus between investment in ICTs and investment in a wide range of other complementary
investments, such as human capital, the organisation of processes both within a firm and
within industries and markets, in order to generate measurable output gains (Brynjolfsson and
Hitt, 2000; 2002; Brynjolfsson and Yang, 1996). Moreover, it is not at all clear that the
complementary processes are themselves ubiquitous, even though the ICTs might be. Rather,
different types of complementary investments may be necessary in different circumstances,
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and the returns to each of these complementary investments may vary substantially across
different sectors of the economy (Bresnahan, Brynjolfsson and Hitt, 1999; Jacobides, et al.,
2006).
The academic literature, therefore, does not dispute that there are economic and social gains
to be made from investment in ICTs.
Indeed, some fifty years after the first
commercialisation of computers, some compelling academic evidence is emerging of
measurable returns that are attributable to ICT investment (Oliner and Sichel, 2000;
Jorgenson and Stiroh, 1999; Stiroh, 2002). However, the realised gains are many orders of
magnitude smaller than the original projections made, and highly sector-specific.
Furthermore, there is evidence that not all of the measured performance increases can be
directly causally attributed simply to the investment in ICTs and their complements.
Waverman and Fuss (2006) demonstrate that not only does investment in ICTs cause
increases in productivity levels, but increases in productivity levels themselves drive
investment in ICTs.
1.2
The Place of Broadband in the ICT Mix
ICTs encompass a range of technologies that create, process, store, transmit and utilise
digitised information. By conceptualising an ‘information product value chain’ (as per Porter,
1990), where digitised information is the input, and products made using digitised
information (which may or may not themselves be digital), transportation is necessary at the
points of both inbound and outbound logistics (note that the ‘product’ may range from be a
complex marketplace transaction with many interactions to a simple one-way message).
Communication technologies thus form an important part of the value chain. However, their
role is one of supporting the production of the good that is ultimately the source of value
created, in just the same way as physical transportation industries support the production of
physical goods.
Transportation matters, but only insomuch as there is a cargo to be
transported. Moreover, transportation contributes only a very small component of the value
of the relevant product markets, either in the delivery of raw materials or the distribution of
end products.
The ‘communication’ (transportation) component of ICTs has assumed increasing importance
and become a key part of the ICT value chain with the digitisation of many types of
information previously captured, stored and transported via other means. Voice telephony
provides an example. New products and new markets, such as digital voice telephony, have
emerged based upon the encoding, transmission and decoding of digital information. The
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same networks that telecommunications firms use to transmit voice data digitised by the
telecommunications company can be used to transmit the digitised information encoded and
decoded elsewhere (e.g. by computer modems). Convergence of a variety of information
forms onto a common digitised format for transportation has led to increased opportunities for
firms capable of transmitting digitised data.
These opportunities include not just voice
telephony and computer data, but also audio (e.g. MP3), pictorial (e.g. JPEG) and video (e.g.
MPEG) data previously transmitted via paper, tape, disc or other media.
Thus, any
transmission medium capable of transmitting digital data (wireless, cellular telephony, fixed
line telephony, cable television, satellite) can now compete for fulfilling the inbound and
outbound logistics roles in ICT-enabled supply chains with the media (e.g. paper, magnetic
tape, compact discs and DVDs) and transportation mechanisms (e.g. postal services, public
switched telephone (PSTN) networks, analogue broadcast transmission) via which these data
were previously transported.
1.2.1
Broadband is the Internet Frontier Technology
The substantial advance that led to the growing ubiquity of digital transportation of data in
both commercial and residential markets was the commercialisation of the Internet in the
1990s. In this respect, the Internet itself is a GPT in its own right (Howell and Obren, 2002;
Howell, 2003). Each GPT goes through processes of technological development. At any
time, the most sophisticated, technologically capable version of the GPT is known as the
frontier. The Internet GPT was enabled by the development of modems (to encode and
decode information) and digital transmission technologies. ‘Broadband’, as the combination
of highly capable modems and transmission capability, is simply the frontier in an Internet
GPT that has passed through a series of modem technologies based upon dial-up telephony
transmission over switched telephone networks, wireless and fibre-optic transmission
infrastructures.
Broadband technologies enable larger amounts of digitised data to be transferred faster over
the Internet than earlier technologies such as dial-up. However, just as with any other form of
transportation technology, or even any other form of production technology, it does not
follow that, simply because the frontier exists, all transportation firms will deploy it, or that
all purchasers of the inbound and outbound logistics services will need the technological
capabilities that the frontier provides. Rather, it might be expected that a variety of transport
mechanisms would be required, to meet the needs of different industries and sectors. Indeed,
using normal investment rationale, the frontier will be invested in only if the value added
from utilising the frontier technology exceeds that derived from the existing investments or
substitute ways of moving the same goods.
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1.2.2
Diffusion of the Frontier Technology
There is no theoretical or empirical evidence in the literature that investment in new, frontier
transportation technologies will of itself stimulate new demand for the products that are
transported, or contribute any more value than is simply able to be leveraged from the
reduced costs or higher value associated with the timeliness of information delivery or the
volumes of data delivered, unless there is underlying demand for the goods which must be
transported. For example, the ‘network effects’ that were associated with the diffusion of
voice telephony occurred because there were people who needed to talk to each other. Absent
the need to talk to other people, the impact of telephony would have been negligible.
Granted, the telephone allowed individuals who would not have communicated with each
other previously to now have conversations. However, these conversations contributed to
increases in economic and social welfare as a consequence of the value the information in the
conversation conferred, rather than the transport mechanism itself. Neither is there any
theoretical or empirical evidence that new transport mechanisms will stimulate the
development of new goods that will be commercially viable only because they can be
transported via the new methods (although the risk exists that existing products might be
inefficiently contorted to suit the new transport methods, if the presence of the new method
leads to the removal of existing methods that would enable these goods to be transported
more cost-effectively).
Rather, demand for and supply of the new products will be determined by the merits of the
end products rather than by the merits of their transport mechanisms (Boudreau, 2006).
Neither will the mere existence of the frontier technology mean that all information users will
find it economically rational to purchase transport based upon the frontier, especially if it
means that they must make substantial additional investments to receive and transmit data in
this form (e.g. building receiving and shipping docks, or purchasing modems of a specific
type). Their propensity to purchase the frontier is based upon the additional value they
perceive they will receive from such investments. As an illustration, whilst rapid-service
couriers deliver packages faster (albeit at higher cost), they service only the small segment of
the courier market for whom delivery time matters sufficiently for a premium over the cost of
a standard, 24-hour courier service to be paid. If timeliness does not matter sufficiently to
pay the premium, then consumers will express their preferences by purchasing the lower-cost,
slower method. There is no reason to believe that, simply because the cargo is digital
information, these trade-offs will not underpin technology choice in Internet transportation
markets.
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When a frontier technology is developed, the rate at which it is adopted will therefore depend
on the additional benefits that it offers relative to the currently-deployed technology. If the
frontier is indisputably superior in cost and quality, then it will be preferred by all new users
(i.e. it ‘dominates’ the existing technology).
Otherwise, it is said to be ‘conditionally
dominant’ – purchasers will select the most efficient version based on their usage patterns. If
the new technology is so superior that the user can derive sufficient additional benefit from it
to cover both the required return on the existing investment and the required return on the
new investment, then the old technology will be abandoned and the new purchased. If,
however, the benefits of the new technology are insufficient to meet this test, the user will
persist with the old technology until its investment cost has been recouped, it is fully used, or
an even newer technology with better economic characteristics supersedes the existing
frontier. Thus, simply because the frontier exists, it does not necessarily mean that either all
users will adopt it, or that they will adopt it at the same time. The time taken for a new
technology to replace an existing one constitutes its diffusion pattern. The diffusion pattern
for a frontier technology such as broadband will be highly dependent upon the extent of
diffusion of the existing technology (i.e. dial-up) and the relative benefits of the frontier over
the existing for all users (which are not identical, given the variety of uses to which the GPT
can be put).
1.3
Diffusion Metrics Economic Performance Measures and Targets
As an indicator of likely economic performance within a knowledge economy utilising a very
wide variety of ICTs, a single frontier technology diffusion statistic relating to a single
subgroup of communication technologies that of themselves only contribute in a very small
way to the accrual of measurable economic value in what is a highly complex nexus of
interrelated investments, in isolation from any of the other complementary investments likely
to influence the degree of benefit gained, is at best likely to lead to highly misleading
conclusions. To base an entire set of economic policy assessments on the basis of this metric,
to the extent that the authors of the Stocktake do, when suggesting that New Zealand’s
performance in broadband uptake is threatening the ability of the Digital Strategy to be
realised, without further examining any of the other complementary and substitute
investments that may also be contributing, appears naïve.
It is also contrary to policy
literature published by the OECD, which concurs broadly with the academic literature cited
above in this respect:
“Having the equipment and networks alone is not enough to derive economic
benefits. Other factors, such as the regulatory environment, the climate for trust and
security in a digital economy, the availability of appropriate skills, the ability to
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change organizational set-up, as well as the strength of accompanying innovations in
ICT applications, also affect the ability of firms to seize the benefits of ICT”.7
The dangers of relying on such a metric, and using it as a driver for investment policy and
regulatory intervention are well illustrated by two common transportation analogies that have
been used extensively in the anecdotes urging businesses and consumers to invest widely in
purchasing broadband technologies, and policy-makers to introduce policies to accelerate
their diffusion. In the first, the time taken for travelling from Melbourne to Newcastle in a
Ferrari compared to cycling has been used to compare the benefits of broadband compared to
dial-up Internet access8. In the second, broadband has been compared to the ‘freezer ships’
that transformed the New Zealand, Australian, Chilean and Argentine economies in the
nineteenth century.
1.3.1
The Relative Value of Speed and Capacity
Whilst it cannot be denied that broadband as a frontier technology offers faster transmission
speeds, and greater transmission capacity than dial-up, it does not follow that all users will
value those characteristics, given the applications from which they derive benefit. Whilst it
might take substantially less time to travel from Melbourne to Newcastle in a Ferrari than on
a pushbike, the difference only matters if the traveller needs to go to Newcastle. If the
traveller never needs to go to Newcastle, but instead only goes to the corner dairy, then the
Ferarri time-saving is largely immaterial, but the capital cost substantially greater. Investing
in the Ferrari may be an inefficient over-investment, tying up cash that could be better used
elsewhere. If cash is not an objective, then a Melbournian may buy a Ferrari and park it in the
garage, in order to have the option of going to fast to Newcastle at some unspecified or
unknown time in the future. However, this is only an efficient action if there are no other
substitutes available to achieve these ends (e.g. hiring a Ferrari when required/accessing
broadband at work), or the substitutes are more costly. The same argument applies to the
capacity offered by broadband, if the vehicle is a Mack truck, and the comparative loads a
loaf of bread and a container load of furniture.
Thus, it is inappropriate to measure the sophistication of a country’s ICT investment policies,
or even its utilisation sophistication, on the basis of a single technology diffusion statistic, in
isolation from analysis of the substitute technologies and the underlying applications which
determine supply of, and demand for, the technology. To set targets based upon the statistic,
7
OECD Meeting of the OECD Council at Ministerial Level. 2003. Seizing the Benefits of ICT in a Digital Economy. Paris:
OECD. p 11.
8
Ref from somewhere
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as a proxy for the ability of the country to compete in a digital economy denies the
importance of the substitutes and the rational analyses made by end users of the actual worth
to them of the technology to them relative to its substitutes. There are real risks that policymakers, often informed principally by the suppliers of the frontier technology (who have their
own vested interests), might substantially overestimate the value of the frontier to end users.
For example, United States residential survey data shows that over 60% of dial-up Internet
users have no plans to switch to broadband as dial-up access meets their current needs. Of
this 60%, 22% said that dial-up suffices as they have access to broadband at work (Horrigan,
2006:9). Furthermore, only half of new Internet users connect via broadband (p i), suggesting
that the broadband frontier technology is only conditionally dominant. Whilst speed is cited
as the reason for buying broadband by 57% of the broadband respondents, 81% had no idea
what speed their connections were (p iv). Moreover, residential ‘clickstream’9 data from the
United States shows that there are no substantial differences in the applications used by dialup and broadband users, except for three specific application types – gaming, gambling and
video entertainment (Rappoport, 2003).
1.3.2
Investment in Broadband Drives Economic Growth?
The ‘freezer ship’ analogy has been used as an example of how a single technology can
transform an economy, and has been offered as a prototype for the potential transformational
effects of broadband. However, this example illustrates that, even when such a technology
facilitates a transformation, the ability to do so relies upon the presence of many other factors
in the economy, may be sector-specific, and the gains may accrue unevenly across an
economy – in this case at the point of production of the relevant goods rather than at the point
of consumption. This example also highlights that investing in the transport mechanism
comes secondary to the presence of the other economic factors, and that relying upon
widespread availability of a transportation technology to stimulate the development of new
investment in the underlying factor and product markets is counterintuitive, and policies
based upon such premises therefore flawed. Moreover, the example highlights that the effects
of a new technology are not always positive ones, as the reallocation of production and
consumption as a consequence of the new transportation technologies has negative effects for
some parts of the economy. Once again, the distribution of the value depends upon the
underlying demand and supply of end goods and services.
Despite the undeniable effect that freezer ships had on the New Zealand economy, the nexus
between the number of freezer ships and economic growth is very difficult to draw. Firstly,
9
Data collected and analysed from actual activity undertaken by the Internet users – this is a much more reliable way of tracking
actual usage of the Internet than self-reported survey data which is often used to assess individuals’ usage patterns.
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even with the benefit of historic information, it is impossible to determine the exact dollar
contribution to total economic welfare created by each freezer ship. Secondly, even if the
share attributable to transportation separate from the value placed on the goods moved can be
ascertained, it is even more difficult to determine how the welfare has been allocated across
the various sectors of the economies in the various countries where the freezer ships plied
their trade. As transportation is an ‘intermediate’ service, it is very difficult to attribute its
value in regard to either the products its presence enables to be created and sold (recorded in
the production accounts), or consumed (recorded in the consumption accounts).
Thirdly,
freezer ships were part of an economic transformation that occurred in some countries (e.g.
New Zealand), but not others (e.g. India), due to the different underlying industries in each
country.
Whilst on the one hand, the presence of freezer ships enabled the development of new
markets for (and hence fuelled the expansion of) industries already present in New Zealand
(as well as Australia, Chile and Argentina), which was recorded in New Zealand’s GDP as
substantial increases in agricultural sector production, most of the ‘value added’ that was
created was as a consequence of the value that the end consumers placed upon the resulting
dairy and meat products that they could now access. Whilst transportation enabled this value
to be realised, without the pre-existing demand for the goods, there would have been no
market. Welfare was created for the consumers of these goods in the countries to which the
outputs were transported, but it is not at all clear how this has been captured in the national
accounts of the recipient countries. Most certainly, European consumers benefited from
wider choice, lower prices and better quality in the agricultural products that they demanded.
However, lower prices and higher quality in the imported goods led to pressures upon
European agriculture markets where local producers could not compete on price and quality
with the southern hemisphere products. Without the intervention of politicians imposing
quotas on the imported goods, production of agricultural goods in these markets would have
collapsed, to the detriment of measured production (reflected in GDP) in European
agriculture.
Thus, losses, as well as gains, are associated with the arrival of new
technologies.
The analogy also illustrates how inadequately the number of freezer ships, their capacity, or
even the number of docks capable of loading and receiving the ships measure the economic
effect that this method of transportation engendered. There was no simple nexus between the
number of ships and the wealth that they assisted in creating. Furthermore, it would have
been pointless to use the number of ships visiting, or the number of freezer ship-enabled ports
built per capita (akin to broadband uptake) as targets in some form of global medal race
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comparing ‘winning’ or ‘losing’ in the wealth creation stakes in the international meat and
dairy markets. Moreover, it would have been even more foolish to pursue national economic
strategies predicated upon stimulating farmers to alter their farming practices, or consumers to
alter their tastes for, and values placed upon, butter, cheddar cheese and lamb, simply by
commissioning more ships and erecting more ports. Yet these are the same strategies that
have been suggested as reasons why a shortage of applications currently available using the
capabilities of broadband will be ‘solved’ by making more, and more capable, broadband
services available, and waiting for producers and end-users to develop new things to do with
it.
What mattered in the end for the economic performance of all countries involved in the
freezer ship-facilitated industries was the supply of, and demand for, butter, cheddar cheese
and lamb, which ultimately determined the dynamics in the markets for the supply of, and
demand for, transportation. Much better proxies for the economic value created lay in metrics
such as the tonnage of each product shipped, its origins and its destinations, and the prices
paid for the end products, than the prices paid for, and availability of, their transportation.
Whilst transportation prices might have made a difference at the margins of the total value
created in the underlying product markets, they mattered only inasmuch as there was a market
for the supply and consumption of the butter, cheddar cheese and lamb in the first place.
Absent these factors, ships and ports would have been meaningless.
It is the economic theories underpinning such technology diffusion and transportation markets
that have led organisations such as the OECD, the ITU and WSIS to urge caution in the use of
infrastructure connection proxies in measuring economic development. The complexity is
reflected in the multi-faceted WSIS ICT measurement database, that record 10 telephony
infrastructure access metrics, two broadcast media metrics, 14 household access and
utilisation metrics, 12 business access and utilisation metrics and four trade sector metrics
(ITU, 2006:17-18).
1.4
Ordinal Ranks or Cardinal Metrics?
Even if, by any chance, there might have been some merit in counting freezer ships, Ferraris,
Mack trucks or broadband connections, an important issue to be addressed, the ‘Stocktake’
use of ordinal measures (e.g. top half of the OECD) rather than cardinal measures (e.g. x% or
y per 100) as benchmarks and yardsticks for determining ‘success’ is highly questionable.
When the metric concerned is a diffusion statistic of a given technology, then the diffusion in
all markets will follow the typical S-shaped Gompertz curve. The slope of the incline
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measures the speed with which the technology diffuses – a slow-diffusing technology has a
flatter incline than a rapidly-diffusing one.
However, what matters is not the absolute
numbers vertically on the y-axis, but the pattern over time, measured on the x-axis. Diffusion
patterns are typically expressed as the time taken to reach specific percentages of the likely
total future market – for example, the time to 5%, 50% and 90%. That is, both time and level
matter when measuring diffusion.
Taking a level in one setting, in isolation from the time
taken to reach that point, and then comparing it to that observed in another setting, may
simply identify that the respective settings are at different points in their diffusion patterns.
Furthermore, diffusion curves ‘flatten out’ at the top of the ‘S’ when the technology is fully
diffused. This draws into further question the use of rankings as targets to pursue in a
technology diffusion strategy, in isolation from consideration of the level of maturity of the
diffusion of that technology. The point of saturation may occur at different levels of diffusion
in different settings, due to different underlying situation-dependent characteristics. For
example, if the technology is utilised at the household level, saturation will be achieved at a
lower level per capita in a setting where household size is large relative to one where average
household size is small. The former setting will always rank below the latter, simply because
of the different underlying characteristics.
It is pointless to use incentives based upon
improving rank in the former setting, or to measure diffusion ‘success’ on relative ranks, if
these distortions are material and the technology is fully diffused.
The use of ordinal ranks to compare relative performance rather than absolute metrics raises
further questions about the nature and validity of the targets set in the New Zealand Digital
Strategy and endorsed in the Bill. Rankings are reliable only when a standard methodology is
used in the composition of the relevant statistics. For example, if diffusion data are collected
at different times, from different organisations or using different collection methodologies the
validity of comparing them in a raw state, without correcting for these time differences, will
result in misleading conclusions.
Furthermore, if the ordinally-ranked data are based upon sampling, rather than population
data, the numbers compared are estimates, meaning comparisons must take into account the
margins of sampling error incurred as a result of the sampling process (Wallsten and Sacher,
2006). Moreover, the distribution of the numbers being ranked affects how the rankings are
interpreted. Where the sample-based numbers are clustered closely together, then any ordinal
ranking made may be highly arbitrary, as each measure approximated by the sample may be
anywhere within a confidence interval that overlaps with the confidence intervals of each of
many of the other similarly estimated measures. The greater the number of overlaps that
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occur, the less the credibility that can be attached to the exact rankings allocated to each data
point. Single outliers or clustering may also affect rankings. For example, when there are
two clusters of data points (for example, 10 points) with 10 points clustered at a high level
and 4 at a low level, the median measure is cardinally closer to the high cluster, but is ranked
ordinally in the ‘bottom half’ of the sample. This is not necessarily an indictment on the
performance of the numbers 5 and 6-ranked observations when assessed cardinally (for
example, as a deviation from the sample mean), but is viewed pejoratively when assessed
only as a ranking.
These methodological issues are of substantial concern, given that the targets in the Digital
Strategy are expressed as ordinal rather than cardinal objectives, and fail to take into account
any of the issues of the veracity or integrity of the underlying data, the time dimensions in the
diffusion patterns, or any of the underlying situational characteristics that might affect New
Zealand’s ability to reach the articulated target. Furthermore, the key supporting Stocktake
documents (Network Strategies, 2006a; Network Strategies, 2006b) wherein New Zealand’s
broadband ‘problem’ is diagnosed and the ‘solution’ offered, rely almost exclusively upon on
ordinal comparisons when assessing New Zealand’s performance. Thus, substantial doubt
must be cast upon the validity of these findings.
1.5
Alternative Views
In sum, the use of the diffusion statistic ‘broadband uptake’ as the relevant metric, and an
ordinal ranking rather than cardinal targets as performance benchmarks appears to be all of:
•
academically unsubstantiated as a measure of the sophistication of New
Zealand’s ICT investment and use
•
methodologically inappropriate as a target to which to aspire to and upon
which to base policy intervention; and is
•
highly misleading when used in isolation.
This subsection section will assess an alternative set of views to assess New Zealand’s
absolute and relative performance in respect of its ability to generate positive economic value
from the use of the Internet. This approach makes clear distinctions between the various
contributions made by different sectors of the economy which are utilising Internet
technologies, and then rationalises how these factors might be used to determine whether
New Zealand’s low broadband ranking should be a matter of concern. This section takes as
its framework the assumption that measures of broadband uptake per capita are simply
measures of the extent of investment made by end users in the frontier internet technology,
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and that the nexus to measurable economic value depends upon not simply the purchase of
broadband connections, but the use of Internet connections. The locus of measurement will
also depend upon the sector of the economy in which the evidence of Internet use will be
manifested (e.g. demand-side/consumption or supply-side/production).
This section uses
international comparisons, but with the provisos noted in the previous section that the data
may not be always directly comparable. Thus, the measures will be compared on both an
ordinal and a cardinal basis wherever possible.
The framework upon which this analysis is based was originally developed as part of a piece
of work commissioned by the Ministry of Economic Development from the author in 2001,
utilising as a basis the productivity and diffusion literatures referenced above (Howell, 2001),
as an alternative to the infrastructure-focused OECD framework placing connectivity to the
Internet (and by extension, broadband) as the first stage in a sequential path towards the
accrual of economic welfare gains. Whilst the Howell (2001) framework has been enhanced
subsequently, the key principle remains the dynamic and iterative interaction of
infrastructures (measured as connectivity), applications and complementary investments,
measured by utilisation, which provides the best proxy for likely increases in welfare. It has
been the basis for the many assessments made by the author since 2000 of ‘The State of eNew Zealand’, and relies upon not simply single statistics in isolation, but a comprehensive
set of statistics together providing an overall impression of absolute and relative performance.
If all statistics together suggest a consistent impression, then the joint impression should
prevail over that supported by a single outlier.
Figure 1.1
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A Model of Welfare Growth from Infrastructure Investment
-44-
Using this framework, it is not at all clear that New Zealand lags years behind its OECD
competitors in the ability to generate measurable economic benefits from the use of the
Internet. Rather, there is substantial evidence that not only is New Zealand’s broadband
ranking not inconsistent with the country’s general economic performance, but that
investment and use of ICTs generally, and Internet applications in particular, are the
foundation of a very healthy ICT-enabled economy that is out-performing many of the
economies with substantially higher broadband rankings in the OECD ‘league tables’.
1.5.1
Is New Zealand’s OECD Position (22) in Broadband Uptake a ‘Problem’?
In absolute and relative terms, New Zealand’s broadband uptake of 8.1 connections per 100 in
December 2005 is low. However, it is well-demonstrated that there is a strong correlation
between per capita income and uptake per capita of all classes of ICTs (e.g. fixed telephone
lines, mobile telephone connections, personal computers, cellphones, fax machines, Internet
access) than their less wealthy counterparts. Figure 1.2, taken from ITU (2006: 24) illustrates
this relationship. Similar findings also pertain to the uptake of other ‘high-technology’ items,
such as televisions, video and DVD recorders, gaming consoles, satellite and cable television
subscriptions, and MP3 players (see, for example, Rappoport, Kridel and Taylor, 2002).
Figure 1.2
GDP per Capita and ICTs, 2004
The diffusion of these technologies is also highly contingent upon household characteristics,
as all are highly utilised in the residential sector. Thus, residential diffusion likely dominates
national per capita figures. New Zealand has over 1.8 million households and 285,000
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economically significant businesses, but only 0.5% of these businesses employ more than 100
people (Howell, 2003). Analysis undertaken in 2003 showed that, at that point, New Zealand
exhibited proportionately higher numbers of business purchasers of broadband connections
relative to other OECD countries, especially when accounting for the very small size of the
average New Zealand business, compared to the SME segment in other countries such as
Norway, the United Kingdom and Australia (Howell, 2003:48). Thus, the low uptake of
broadband connections in New Zealand is likely being ‘skewed’ by low levels of residential
uptake.
1.5.2
Consistency with GDP per Capita
If low residential uptake is the cause of New Zealand’s low per capita uptake, this may not be
a ‘problem’ in respect of growth in measured GDP per capita, simply because residential
uptake is a consumption measure, whilst GDP per capita is a production measure. Whilst low
uptake may be problematic for specific firms wishing to distribute specific content (e.g. the
high-resolution digital video content which the Stocktake authors claim is the principal
application justifying the roll-out of optical fibre to residential areas), of itself it may not be
acting as a substantial brake on growing New Zealand’s GDP per capita (although it may
affect the ability of some residential consumers to gain the marginal additional personal utility
from the applications supported by broadband-transported data relative to the utility derived
from consuming a substitute, such as from Internet-distributed video-on-demand relative to
pay-per-view Sky TV or DVD rental services, or Internet gaming over playing a real game of
tennis or golf – benefits that are not easily captured in current economic measures).
Rather, reverse causality possibly explains a substantial amount of the difference between
New Zealand’s measure and that of other OECD countries (e.g. Ausdtralia) in broadband
uptake. Low levels of income per capita are likely acting as a substantial brake on the
diffusion of residential broadband, given that its purchase is shown to be highly contingent
upon household income levels in other economies (e.g. the United States – Rappoport, Kridel
and Taylor, 2002), and it is still a relatively lowly-diffused technology (broadband uptake is
still substantially less than dial-up in most OECD countries – OECD, 2005).
This is
confirmed by Figure 1.3. Regressing GDP per capita on broadband uptake per capita using
the December 2005 OECD data results in a very similar correlation to that in the ITU
analyses, with a relatively good fit found using the power model (as illustrated by the high
R 2 value). As New Zealand’s data point (8.1, 23,900) sits only very slightly above the
regression line, if this regression relationship is a good estimate of the actual underlying
relationship, New Zealand’s actual recorded position is not inconsistent. That is, most of the
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difference between New Zealand’s broadband uptake and that of other OECD countries
occurs as a consequence of differences in GDP per capita. By contrast, Korea is an ‘outlier’,
as its broadband uptake is substantially greater than its GDP per capita would suggest.
However, this is accounted for by the substantial government subsidisation of broadband
infrastructure that has occurred in Korea, and likely strong urbanisation and population
density factors.
Figure 1.3
OECD Broadband per Capita and GDP Per Capita, December 2005
70,000
GDP Per Capita, $USD, PPP, 2004
60,000
New
Zealand
y = 10232x0.3805
R 2 = 0.5841
50,000
40,000
30,000
Korea
20,000
10,000
0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Broadband Penetration per 100
Furthermore, on a simple GDP per capita ranking level, New Zealand’s broadband uptake (22
– OECD average falls between the 17th and 18th-ranked countries10) is approximately equal to
its rank in GDP per capita (21). By comparison, New Zealand was 25th in the OECD in the
combined number of fixed and mobile access lines per capita (2.3% lower than the OECD
average – OECD average falls between the 23rd- and 24th-ranked countries), which are both
nearly fully-diffused technologies in the OECD. The left-hand graph in Figure 1.2 captures
the equivalent ITU data for the whole world. Incidentally, the 23rd and 24th-ranked countries
in this metric are the United States and Canada respectively. Despite New Zealand’s low
absolute ranking, the deviation from the OECD average is materially very small, and even
high-GDP countries rank lowly in this metric, probably as a consequence of factors entirely
unrelated to the sophistication of the telephony market (e.g. household size).
10
This analysis shows that a countries 16 and 17 in the December 2005 rankings (Austria and Austrralia) are in the ‘bottom half’
of the OECD on rankings, despite exhibiting above-average uptake.
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These findings illustrate the problems identified above associated with using relative rankings
for technologies at different levels of diffusion. Neither the United States nor Canada would
be classified as backward ‘failures’ in their telephony diffusion strategies by most standards,
yet by the ranking methodology that is applied to New Zealand’s broadband uptake, they
would be. If individual wealth is considered a significant factor in the early diffusion of the
frontier technology broadband, given that other alternative Internet access technologies exist,
then New Zealand’s December 2005 ranking is not necessarily a ‘failure’ either. Rather, it
could simply be a reflection of the fact that, given current application bases, costs, existing
utilisation patterns and the application bases used by residential consumers, along with
constrained budgets, especially at the household level, a compelling cost-benefit trade-off
does not exist at the present point in time sufficient to motivate new residential users to
purchase the frontier when embarking upon Internet access, or for existing residential users to
abandon existing investments in favour of the frontier.
1.5.3
High Levels of Internet Uptake and Usage
The latter arguments take on greater credence when examining the nature of New Zealanders’
use of the core GPT, the Internet. There is no evidence to suggest that New Zealanders are
low users of the Internet. By contrast, by OECD standards, New Zealanders have been all of
very early adopters, very prolific adopters and very heavy users of the Internet. The various
‘State of e-New Zealand reports have tracked the New Zealand’s absolute numbers and
relative rankings of the number of individuals accessing the Internet, by a variety of measures
such as Internet hosts per capita (the number of unique computers connected to the Internet),
the number of ISP accounts per capita, the number of web sites per capita, and other
‘connectivity’ data.
By both ordinal and cardinal metrics, New Zealand has been a
consistently high performer.
1.5.3.1 World-Leading Internet Uptake
As an example, the latest ITS statistics (reported in Table 1.1) show New Zealand to have, in
September 2005, the highest percentage of Internet users per capita of all countries not just in
the OECD, but in the world. New Zealand’s percentage (76.3%) is 15% higher than the
average of the top 30 countries in this measure. Compared to other countries with which New
Zealand competes, this statistic is 2% higher than that exhibited by Sweden, 10% higher than
Denmark, 11% higher than the United States and Australia, 13% higher than Korea, 16%
higher than the Netherlands, 21% higher than the United Kingdom and 30% higher than
Germany.
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1.5.3.2 High Levels of Hours per Dial-Up Account per Month
The high levels of Internet uptake have been noted by international commentators from as
early as 2000, when the OECD identified the role of unmetered telephony pricing as a factor
in the ability of individuals in four countries – Australia, New Zealand, Canada and the
United States – to use dial-up Internet access without incurring per-minute telephony call
charges (OECD, 2000). Thus, users in these countries could have ‘always on’ Internet access
at no additional cost – a feature that is attributed as a key value-adding factor for customers of
broadband in countries where per minute telephony charging might have been depressing
dial-up Internet usage.
The high levels of dial-up Internet usage in New Zealand are captured in 2003 by Howell
(2003) and in 2002 by Howell and Obren (2002). In 2003, New Zealand had over 850,000
active Internet (ISP) accounts, with an average time connected per account (measured from
population data collected by the single Telecommunications provider) of 34.5 hours per
month (Howell, 2003:22) (this compares to AOL averages estimated from surveys of around
30 hours per month). Furthermore, despite already having very large numbers of dial-up
Internet users, new dial-up accounts representing users with more marginal demands still
being opened, and substitution to broadband already beginning, average usage per account
was remaining stable at the level that had prevailed since 2000 (although by some models, it
may have begun to decrease slightly) – Figure 1.4.
Figure 1.4
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New Zealand Dial-up Minutes per Account
-49-
1.5.3.3 Application Bases
New Zealanders’ high levels of connectivity and usage of thee Internet appears to be
accounted for by use of a wide number of applications that will lead to measurable economic
benefits. One example is the popular online trader TradeMe. The trader reported 1,179,313
unique registered members in February 2006 (28% of the population), recorded 598 million
page impressions (average of 507 per registered member) in this month (from 2,117,504
unique browsers, suggesting most members visit the site from at least two locations – e.g.
home and work), and mediated sales to the value of $300 million in the preceding year11. In
November, 2005 it was reported by NielsenNet//Ratings to have surpassed web portal
XtraMSN as the most visited site in New Zealand12. Thus, an online marketplace is the most
used application in the country. This differs from most other OECD countries, where the
most visited site is usually a web portal, such as XtraMSN.
Whilst some of the trade conducted on TradeMe would substitute for transactions that would
otherwise have been conducted via other means (e.g. classified advertising, car boot sales and
garage sales), the site has enabled many vendors to receive higher prices for unique items by
offering exposure to a wider market. The heavy usage of TradeMe is thus undeniably
contributing directly to changes in economic welfare that will ultimately be measured in
economic statistics. However, it is not dependent upon broadband connections. Founder Sam
Morgan has been reported as saying that the site is designed not to look too flashy13, meaning
that it has low bandwidth requirements, and is therefore poses few access barriers to
individuals accessing the Internet via dial-up.
1.5.3.4 Secure Servers per Capita
The role played by electronic commerce in the New Zealand economy, and the pervasiveness
of such transacting right down to the consumer to consumer level of TradeMe is reflected in
other infrastructure figures where New Zealand’s performance is substantially in excess of
that exhibited by other countries with much higher broadband uptake. For example, New
Zealand has consistently exhibited very high numbers of secure servers per capita since 2000.
Secure servers are considered essential for the exchange of data that might be commercially
sensitive – such as credit card and bank account details when transacting online, or for the
exchange of data that would be useful to a competitor. Thus, secure servers per capita are
considered a good proxy for the proportion of commercial activity that is supported by
internet information exchange.
11
12
13
http://www.scoop.co.nz/stories/BU0603/S00109.htm
http://www.nzherald.co.nz/topic/story.cfm?c_id=363&objectid=10354562
http://www.istart.co.nz/index/HM20/PC0/PVC197/EX245/AR22656
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Table 1.2 shows that New Zealand was 4th in the OECD in 2004 in the number of secure
servers per capita (after Iceland, the United States and Canada), with over 1.6 times the
OECD average. Australia is 6th (1.5 times) and the United Kingdom 8th (1.3 times the OECD
average). High broadband-uptake countries Norway, Finland, the Netherlands, Japan and
Korea all have fewer secure servers than the OECD average. The most notable of these is
Korea, which at 26th position, with an uptake in this metric that, at 1.8 per 100, records only
7% of the OECD average. This suggests that, despite Korea’s very high broadband uptake,
very little of the connectivity is being utilised for transactions that require information
security. The conclusion is, therefore, that use of the Internet in Korea is primarily to support
non-commercial activity (e.g. entertainment).
Furthermore, New Zealand exhibits high numbers of transactions per capita on the secure
servers. Thus, the evidence shows that high penetration of this technology is supported by
usage. Table 1.3 shows that in 2004, New Zealand was 5th in the OECD in the number of
transactions per capita placed through secure servers (2.5 times the OECD average). Not only
is the penetration of the technology high, but usage levels are consistent with server numbers.
New Zealand’s transaction numbers are 8% higher than Australia’s (7th), 63% higher than the
Netherlands (10th), 1.7 times that of the United States (13th), 2.6 times that of the United
Kingdom (16th), 2.8 times that of Japan (17th) and a staggering 15.6 times that of Korea (27th).
Interestingly, despite Iceland (3rd) having more than twice the number of secure servers per
capita of New Zealand, the number of transactions per capita placed through these servers is
only 3.7% higher than New Zealand’s volume. It is noted that most of the traffic volume to
TradeMe is not processed via secure servers, as the actual sales mediated by this site are
transacted via sites such as SafeTrader and the electronic banking facilities of the major
trading banks. However, many of the transactions completing sales brokered on TradeMe
will be recorded on the secure servers of the banks.
Thus, without doubt, TradeMe sales
will be influencing this transaction volume
1.5.3.5 Other Commercial Infrastructure
The relatively extensive use by New Zealanders of the Internet for commercial activity is
further reinforced by statistics collected on the nature of Internet traffic exchange data. For
example, the number of routed autonomous systems per 100,000 inhabitants measures the
extent of use of “networks with their own distinctive routing policies which appear in the
Internet routing table” (OECD, 2006:6).
Autonomous routed systems are important for
enterprises who wish to exercise greater independence and flexibility over their networks and
the ways in which they exchange their information over the Internet by controlling their own
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network identifiers and negotiating separately with providers of backbone services how and
where their data will be carried over the Internet. This is presumed to be important for
organisations for which Internet-mediated information exchange is a very large and
commercially important part of their activity. The OECD notes (OECD, 2006:16) that “those
countries with a large number of Autonomous Systems have well-developed Internet
markets”.
Once again, New Zealand was in the OECD top quartile in routed autonomous systems per
100,000 population (7th) in May 2005, with 1.8 per 100,000 (40% above the OECD average),
slightly behind Australia (6th, 46% above OECD average). The leaders are Iceland and the
United States. The Netherlands lies in 10th place (7.6% above OECD average) and the United
Kingdom 13th place (85% of the OECD average). Korea (15th, 70%), Belgium (23rd, 38%)
and Japan (27th, 23%) all lie below the OECD average (data from OECD, 2006:45).
Two measures that capture the extent to which autonomous systems contribute to the amount
of Internet use that occurs are the number of routed IP addresses that autonomous systems
‘inject’ into the routing table (i.e. a proxy for the number of Internet connections the systems
are managing) and the number of synthetic prefixes (for a fuller description, see OECD,
2006:17-18). Consistent with the number of autonomous systems exhibited, New Zealand is
also in the top quartile of the OECD in these measures as well (7th and 4th respectively).
1.5.4
Output Statistics
The figures presented above serve to reinforce that the level of Internet connectivity and
sophistication as applied for commercial endeavour in New Zealand is squarely in the top
quartile of the OECD, and has consistently been in that position for many years. This Internet
sophistication occurs off the base of underlying investments in other ICTs for productive
purpose, because all internet information exchange is mediated at some point by the use of
other ICTs (e.g. computers, mobile phones). Thus it is not surprising to find that productivity
data in the national accounts appear to support New Zealand’s ability to leverage investment
in ICTs into for measurable output benefits. For example, Figure 1.5, taken from the OECD
Database, shows New Zealand to be one of the better-performing countries in the share of
ICT value-added in business sector value-added in both 1995 and 2001.
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Figure 1.5
Share of ICT Value-Added in Business Sector Value-Added, 1995 and 2001
%
20
1995
2001
16
12
8
4
0
Mexico
Slovak Republic (1,5)
6. 2002.
Greece (1,3,5,9)
5. ICT wholesale is not available.
2. 1996 instead of 1995.
Germany (1,5)
Belgium (6)
Italy (6)
Japan (5,8)
Canada
Portugal (1,2)
Spain
Australia (7)
Norway
France
EU 14
Austria (6)
Denmark (6)
Czech Republic (1,5)
Sweden
Netherlands
OECD 25
Hungary (4)
New Zealand (3)
United Kingdom
United States (2)
Korea (1)
Ireland
Finland
1. Rental of ICT goods (7123) is not available.
3. Postal services included with telecommunication services. 7. 1998/99 and 2000/01
4. 1998 instead of 1995.
Source: OECD estimates, based on national sources; STAN and National Accounts databases,
March 2004.
1.6
What is the New Zealand ‘Problem’?
Given that there is no substantial evidence that New Zealand is lagging the rest of the OECD
in respect of the use of the Internet for economic and social gain as measured in the
commercial use of the technology, a question must be asked why low levels of residential
broadband uptake are a matter for concern. To address this question, it is necessary to
consider the features and applications that residential broadband supports, and an assessment
must be made of their importance in respect to the wider economic and social goals of the
policy.
1.6.1
How ‘Valued’ are Broadband Features?
Whilst much has been made of the fast speed, capacity and ‘always on’ features of broadband
relative to dial-up by the suppliers of broadband products and services, it is far less clear how
these features are valued by consumers, and the prices that they are prepared to pay for them
relative to the alternatives. As has already been demonstrated, the ‘always on’ feature may be
less relevant in countries where unmetered telephony and high uptake of dial-up has been the
norm. Low uptake of broadband in Australia, New Zealand and the United States may be in
part attributable to the low price of the dial-up alternative (Hausman and Sidak, 2002;
Wallsten and Sacher, 2006; Howell, 2003). Higher quality of New Zealand dial-up access
(Howell, 2003) and the use of accelerators (Wallsten and Sacher, 2006) may be contributing
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to depressed uptake (noting that the United States’ fall from 4th in the OECD rankings in 2002
to 12th in 2005 has been even more dramatic than New Zealand’s fall from 20th to 22nd over
the same period).
1.6.1.1 Connection Speed
Connection speed, whilst often cited as a key feature, may not be as valuable in the residential
market for users of some applications. For example, Varian’s (1999; 2002) INDEX studies
assessing the amount individuals were prepared to pay for faster access indicated that
individuals appeared to place a very low valuation of their own time when making the
decision about how much more they were prepared to pay for faster transmission, and that the
preparedness to pay was linked to user features in surprising ways – for example, clerical and
administration individuals were prepared to pay more for fast connections than academics,
even though the academics’ time was valued more highly for accounting purposes –
suggesting that the ability to multitask and the time criticality of other outputs might be
significant influences upon the purchase decision.
1.6.1.2 Connection Capacity
Connection capacity has also been used as a key feature of broadband, as the high speed
means large quantities of data can be exchanged. However, despite the high expectations
held of broadband users exchanging large amounts of data, the actual usage patterns appear to
be highly skewed. Anecdotal evidence abounds that very large quantities of bandwidth are
consumed by a very small number of users, with most users having quite modest demand
patterns. Whilst data to confirm this is sparse, two reliable population-based sources reveal
that, in reality, most broadband users consume very little bandwidth, even though they have
the opportunity.
Howell (2003) found that in New Zealand, even residential users with access to generous
downloading allowances used very little of their capacity. In February 2003, of residential
users with a 5Gb monthly allowance, 80% consumed less than 2Gb. Average consumption
was 1.5Gb/month, whilst the median was only 0.7Gb/month. Similar patterns are evident in
Australian data recorded by the Australian Bureau of Statistics14 and summarised in Table
1.3. These data show that residential broadband usage in Australia the September quarter
2003 (roughly contemporaneously with the Howell (2003) data) averaged 1.3Gb/month
(business usage2Gb/month, with a weighted average overall of 1.5 Gb/month). By the March
14
http://www.abs.gov.au/ausstats/[email protected]/e8ae5488b598839cca25682000131612/6445f12663006b83ca256a150079564d!Open
Document
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quarter 2005 (the last time the data were reported), residential consumption had grown to an
average of just over 2Gb/month (business 2.6Gb/month) with a weighted average of
2.2Gb/month. These figures also show that the average consumed per account fell between
the September 2004 and the March 2005 quarters, when the number of residential connections
rose by 42%.
These data suggest that in Australia, new broadband users are actually much lower consumers
of bandwidth than existing broadband users. This is supported by the corresponding changes
in the dial-up usage data. Whilst residential usage per broadband account fell by 9.25% in
this period, dial-up bandwidth consumption rose by 11.8% (subscribers fell by 4.4%),
suggesting that the substitution that occurred from dial-up to broadband was dominated by the
movement across technologies of lower-than-average bandwidth consumers. By contrast,
business bandwidth usage across both technology types is steadily increasing.
If the
Australian and New Zealand data are indicative of consumer usage elsewhere (this appears to
be confirmed, at least in respect of the United States, by the findings of authors such as
Wallsten (2006) and Horrigan (2006), and is highly plausible given that both countries have
been identified as Internet usage leaders), then it is highly likely that there is a vast gap
between supplier-led industry expectations about how consumers might use the Internet, what
they use it for, their preparedness to pay for additional services, and how consumers actually
use the technology once they have purchased it.
Specifically, a pattern is evident in the Australian data that new broadband accounts are sold
predominantly to new residential Internet users who, as inexperienced users, have initially
very small bandwidth demands.
(March 2005 data show that the increase in business
broadband accounts matches the decrease in business dial-up accounts, but the number of
additional residential broadband accounts is 2.4 times the decrease in residential dial-up
accounts). This pattern is confirmed in the United States by Horrigan (2006). Experienced,
heavy dial-up users are choosing to remain on dial-up, whilst inexperienced users have a
preference for broadband. This is inconsistent with broadband being a dominant technology.
Rather, it exhibits only conditional dominance – hence the substantial preference for it by new
Internet users, while substitution by experienced users is not occurring.
The population-based Australian and New Zealand empirical data, supported by anecdotal
evidence in other markets, thus reveal that whilst a very small number of users have high
bandwidth demands, the vast majority of users have very modest requirements. Unless there
are a significant number of compelling new high-bandwidth applications that will appeal to
the very large numbers of the current low-bandwidth consumers and will replace (substitute
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for) existing household spending especially in the leisure/entertainment market segments,
then the forecasts of future bandwidth demand, including the espoused requirements for
super-fast residential connections and plans allowing for very large amounts of data transfer
at very low prices, may be predicated upon the demand patterns and future expectations of
only a very small proportion of residential users. A very real danger exists of policies being
developed on the basis of the demand projections of the exceptional rather than the average
user. That is, policies predicated upon all users needing Ferraris and Mack Trucks may lead
to infrastructures being built that will never be fully utilised, much as occurred in the dot-com
boom of the 1990s. Other transport infrastructures, such as roading, are typically predicated
upon average needs rather than exceptional needs (e.g. autobahns may be nice for some users,
but we don’t build all roads as autobahns simply because a handful of users would like to use
them exclusively).
1.6.1.3 Future Applications
The Stocktake cites two applications which have been identified as requiring high speed
connections in residential areas – video streaming and Internet-based telephony (VoIP).
Whilst VoIP is feasible with relatively modest bandwidth speed and capacity, the demand for
very high speed capacity is driven principally by the need for video streaming. Most of the
residential demand for such capacity has been driven by the demand for Internet-based
distribution of video-on-demand – that is, the distribution of video-based entertainment.
Whilst such services offer increased choice, the marginal benefit to users of this application
needs to be netted off against the current spending on video-based entertainment – for
example, DVD purchase and hire, and pay television subscriptions, many of which provide
some pay-per-view options, albeit with some timing constraints. The extent to which these
applications will be welfare-enhancing must be assessed in relation to the costs and benefits
of the new application relative to the close substitutes. If the substitutes constitute a large part
of the consumer economy, then changes to the means of transportation may have significant
effects on measured spending. However, if they constitute only a small part, then the overall
effect will be small are small.
In practice, most of the benefits of accessing streamed video will likely accrue in the
unmeasured additional benefits that consumers enjoy from greater choice. The number of
movies that an individual consumer views may not change in total, but utility gained will rise
due to the greater choice that video on demand offers. However, the additional value is
confined to those individuals who choose to spend leisure time and dollars on video
entertainment, or who are prepared to pay a premium for the option of being able to have a
wider range of material to view if and when they choose to utilise this form of entertainment
8/11/2006
-56-
(akin to the ‘option’ of having a television set or a pay-tv subscription, even though they are
not utilised frequently).
The better the quality of the substitutes (e.g. a wide range of
broadcast or pay-tv programming, an extensive local video and DVD library, the turn-around
of post-based DVD hire services), the less valuable video on demand becomes. If video on
demand is the sole application currently underpinning the demand for very high-speed
residential broadband, then it must be questioned whether the issue is one that is appropriately
addressed as a matter of telecommunications policy or as one of broadcasting policy.
1.6.1.4 Different Policies for Different Sectors
If, as it appears, different applications are driving demand for different sorts of transportation
services in the business and residential broadband markets, then this needs to be taken into
account when formulating policies the technological needs of different sectors of the market.
If it is deemed necessary to stimulate the provision of particular services in different markets,
then the objectives of the policies designed to stimulate such changes must be clear, in order
to ensure that the appropriate tools are selected. As it stands, the broadband policy objectives
in the unbundling proposals are not clear at all about what the objectives are, beyond reaching
a target in international league tables that must, by its very nature, be predicated upon
ubiquitous residential uptake.
1.7
Summary
If there is to be any merit in pursuing broadband connectivity as an end objective, then
policies must be chosen on the basis of a rational analysis that the benefits are both material
and positive, and reasonably likely to ensure as a consequence of the selected policies. It is of
significant concern that the Stocktake provides no evidence of any such exercise being
undertaken. As the preceding analysis has illustrated, such an exercise is an extremely
complicated undertaking, requiring the understanding and balancing of a very large number of
facts, figures, theories and empirical evidence. However, it is fundamental to the formation
of realistic goals, reliable measures to assess performance and consistent and coherent
policies that support substantiated objectives.
In the absence of such a foundation, the outcomes desired from the unbundling proposals
have been set unrealistically, and are most unlikely to be achieved. If broadband uptake
targets are a legitimate policy objective, then they must be substantiated by much more
focused targets and aspirations than simply to increase GDP and societal welfare. As it stands,
the Telecommunications Bill unbundling proposals are highly risky because of the lack of
8/11/2006
-57-
such principled underpinning analysis. If expectations are set on the basis of the type of
analysis provided in the Stocktake, then the policy has a high risk of failure.
8/11/2006
-58-
Table 1.1
Countries With The Highest Internet Penetration Rate
TOP 30 COUNTRIES WITH THE
HIGHEST INTERNET PENETRATION RATE
#
Country or Region
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
New Zealand
Iceland
Sweden
Falkland Islands
Denmark
Hong Kong
United States
Australia
Canada
Norway
Singapore
Japan
Korea, (South)
Greenland
Switzerland
Netherlands
Faroe Islands
United Kingdom
Finland
Bermuda
Taiwan
Germany
Luxembourgh
Portugal
Austria
Liechtenstein
Guernsey & Alder.
Barbados
Ireland
Estonia
Penetration
(%
Population)
Internet
Users
Population
Source and Date
Latest Data
( 2006 Est. )
of Latest Data
76.30%
3,200,000
4,195,729
ITU – Sept/05
75.90%
225,600
297,072
ITU – Sept/05
74.90%
6,800,000
9,076,757
ITU – Oct/05
70.40%
1,900
2,699
CIA – Dec/02
69.40%
3,762,500
5,425,373
ITU – Sept/05
69.20%
4,878,713
7,054,867
Nielsen//NR Feb./05
68.60%
205,326,680
299,093,237
Nielsen//NR Jan/06
68.40%
14,189,557
20,750,052
Nielsen//NR Jan/06
67.90%
21,900,000
32,251,238
eTForecasts Dec/05
67.80%
3,140,000
4,632,911
C.I.Almanac Mar/05
67.20%
2,421,800
3,601,745
ITU – Oct/05
67.20%
86,300,000
128,389,000
eTForecasts Dec/05
67.00%
33,900,000
50,633,265
eTForecasts Dec/05
66.50%
38,000
57,185
ITU – Oct/05
66.00%
4,944,438
7,488,533
Nielsen//NR Jan/06
65.90%
10,806,328
16,386,216
Nielsen//NR Jun/04
64.50%
32,000
49,598
ITU – Dec/05
62.90%
37,800,000
60,139,274
ITU – Oct/05
62.50%
3,286,000
5,260,970
ITU – Sept/05
ITU – Oct/05
60.70%
39,000
64,211
60.30%
13,800,000
22,896,488
CIA Mar/05
59.00%
48,721,997
82,515,988
Nielsen//NR Jan/06
58.90%
270,800
459,393
ITU – Sept/05
58.00%
6,090,000
10,501,051
C.I.Almanac Mar/05
56.80%
4,650,000
8,188,806
C.I.Almanac Mar/05
56.70%
20,000
35,276
CIA – Dec/02
56.50%
36,000
63,683
ITU – Oct/05
56.20%
150,000
266,731
ITU – Sept/05
50.70%
2,060,000
4,065,631
C.I.Almanac Mar./05
50.00%
670,000
1,339,157
ITU – Sept/05
66.20%
519,461,313
785,179,437
IWS – Mar/06
Rest of the World
8.80%
503,401,994
5,714,517,623
IWS – Mar/06
World Total Users
15.70%
1,022,863,307
6,499,697,060
IWS – Mar/06
24
25
26
27
28
29
30
TOP 30 in Penetration
NOTES: (1) Only countries with a Penetration Rate higher than 50% qualify for this list. At present only 31 countries and
territories meet this condition. Malta was removed from the list till its statistics are verified. (2) The Internet Penetration
Statistics were updated as of March 31, 2006. (3) Population numbers are based on the data contained in worldgazetteer.com. (4) The most recent usage information comes from data published by Nielsen//NetRatings , ITU ,
Computer Industry Almanac and other trustworthy sources. For definitions please refer to the surfing guide. (5) Data from
this site may be cited, giving due credit and establishing an active link back to Internet World Stats. ©Copyright 2006,
Miniwatts Marketing Group. All rights reserved.
8/11/2006
-59-
Table 1.2
July
1998
OECD Secure Servers per Capita, 1998-2004
July
1999
Secure servers per 100 000 inhabitants
July
July
July
2000
2001
2002
July
2003
July
2004
CAGR
19982004
Iceland
4.7
10.5
23.8
31.9
47.3
58.5
85.7
63.6
United States
5.3
11.5
23.2
30.1
37.1
41.5
67.9
54.3
Canada
3.1
5.9
12.7
19.5
24.8
29.6
47.9
59.3
New Zealand
2.4
5.9
12.4
19.9
24.7
27.8
41.3
62.7
Luxembourg
2.6
6.0
10.0
15.4
21.7
23.1
40.9
59.9
Australia
3.4
6.9
14.7
19.0
23.8
24.2
40.4
52.9
Switzerland
United
Kingdom
2.1
5.6
11.8
18.8
21.2
23.9
38.2
62.8
1.2
3.0
7.5
13.4
17.4
19.7
34.3
74.8
Sweden
1.6
4.6
9.1
14.2
14.0
16.0
31.5
64.0
Denmark
0.8
2.1
5.4
9.8
12.3
16.5
31.2
83.5
Ireland
1.5
2.6
6.4
12.1
14.7
17.6
30.1
66.7
Norway
1.2
2.9
6.1
10.9
11.6
14.6
24.6
65.3
Finland
1.3
3.5
6.6
12.7
14.3
16.7
24.1
62.6
Netherlands
0.8
1.9
3.4
6.6
8.2
10.6
22.2
74.6
Austria
1.2
3.0
5.6
11.0
11.8
13.3
19.6
59.1
Germany
0.6
2.0
4.6
7.8
9.7
9.6
16.0
72.9
Japan
0.3
0.9
2.3
6.2
5.6
8.2
15.4
89.1
Belgium
0.5
1.6
2.6
4.2
4.2
4.9
8.8
61.2
Spain
0.6
1.1
1.9
3.0
3.2
4.3
6.7
50.2
France
0.4
1.0
2.1
3.2
4.1
4.3
6.2
60.5
Portugal
0.3
0.6
1.1
1.9
2.1
2.7
4.2
59.4
Italy
Czech
Republic
0.3
0.7
1.4
2.2
2.0
2.3
3.4
51.0
0.2
0.9
1.9
3.7
1.8
2.1
3.1
59.7
Greece
0.1
0.4
0.8
1.6
1.6
1.6
2.5
79.8
Hungary
0.2
0.3
0.9
1.6
0.8
1.2
2.0
49.3
68.8
Korea
0.1
0.2
0.5
0.8
1.2
1.3
1.8
Poland
0.1
0.2
0.5
1.2
1.0
1.0
1.5
70.1
Turkey
Slovak
Republic
0.0
0.1
0.2
0.4
0.6
0.6
1.2
122.7
0.3
..
0.8
2.0
0.7
0.9
1.1
26.3
Mexico
0.0
0.1
0.2
0.3
0.3
0.4
0.6
69.0
OECD
1.8
3.9
8.1
11.7
14.1
16.0
26.5
58.1
EU15
0.7
1.7
OECD Communications Outlook 2005
Table 5.10
3.8
6.5
7.8
8.7
14.6
68.2
8/11/2006
-60-
Table 1.3
OECD Countries: References to Secure Servers, 2002-4
Links to https
August 2002
Links to https
September 2004
CAGR
(2002-2004)
Per 100
inhabitants
Switzerland
155 000
825 000
130.7
Canada
298 000
2 730 000
202.7
8.6
Finland
100 000
419 000
104.7
8.0
Iceland
11.1
2 620
15 800
145.6
5.4
New Zealand
67 100
212 000
77.7
5.2
Norway
42 800
222 000
127.7
4.9
Australia
167 000
901 000
132.3
4.5
Denmark
8 610
242 000
430.2
4.5
Sweden
34 000
318 000
205.8
3.5
Netherlands
48 800
523 000
227.4
3.2
Luxembourg
4 750
14 200
72.9
3.2
Austria
1 830
254 000
1078.1
3.1
2 150 000
8 960 000
104.1
3.1
United States
Germany
482 000
2 410 000
123.6
2.9
Czech Republic
68 000
260 000
95.5
2.5
United Kingdom
279 000
1 190 000
106.5
2.0
Japan
403 000
2 370 000
142.5
1.9
1 600
71 500
568.5
1.8
31 900
171 000
131.5
1.7
Ireland
Hungary
Spain
156 000
572 000
91.5
1.4
Belgium
5 810
141 000
392.6
1.4
France
84 100
773 000
203.2
1.3
2 030
71 000
491.4
0.7
Italy
64 600
356 000
134.8
0.6
Poland
21 300
199 000
205.7
0.5
Greece
1 700
55 700
472.4
0.5
Korea
17 800
161 000
200.7
0.3
Turkey
39 300
178 000
112.8
0.3
1 440
12 600
195.8
0.2
Portugal
Slovak Republic
Mexico
65 100
40 300
-21.3
0.0
OECD
4 805 190
24 668 100
126.6
2.1
EU 15
3 792 580
19 604 300
141.1
1.9
OECD Communications Outlook 2005, Table 5.12
8/11/2006
-61-
Table 1.4
Internet Activity Data, Australia: 2003-5
2003
2004
2005
March
Quarter
Sept
Quarter
March
Quarter
Sept
Quarter
March
Quarter
Subscribers(b)
Dial-up
Non
dial-up
Total
Business
‘000
520
505
499
524
433
Household
‘000
4,087
4,017
3,859
3,916
3,744
Total
‘000
4,607
4,522
4,359
4,441
4,177
Business
‘000
139
190
241
321
412
Household
‘000
331
499
620
979
1,391
Total
‘000
470
690
861
1,300
1,802
Business
‘000
659
696
740
846
845
Household
‘000
4,417
4,516
4,480
4,895
5,135
Total
‘000
5,076
5,211
5,220
5,741
5,980
Business
million MBs
-
178
137
253
304
Household
million MBs
-
1,341
1,457
1,465
1,566
Total
million MBs
-
1,520
1,594
1,718
1,870
Business
million MBs
-
1,169
1,294
2,307
3,255
Household
million MBs
-
1,976
3,521
6,979
8,999
Total
million MBs
-
3,145
4,815
9,287
12,254
Business
million MBs
782
1,347
1,431
2,560
3,559
Household
million MBs
2,264
3,317
4,978
8,444
10,565
Total
million MBs
3,046
4,665
6,409
11,004
14,124
Data DownloadedI(d)
Dial-up
Non
dial-up
Total
(b) As at the end of the reference quarter.
I The collection of separate access technology details commenced from the September quarter 2003 for Internet access lines and
data downloaded.
(d) During the three months up to the reference date, also referred to as the reference quarter.
Source http://www.abs.gov.au/ausstats/[email protected]/e8ae5488b598839cca25682000131612/6445f12663006b83ca256a150079564d!OpenDocument
8/11/2006
-62-
Per Account Utilisation
2003
2004
2005
March
Sept
March
Sept
March
Quarter
Quarter
Quarter
Quarter
Quarter
Business
352.48
274.55
482.82
702.08
Residential
333.83
377.56
374.11
418.27
Total
336.13
365.68
386.85
447.69
Dial-up
Mb per subscriber per quarter
Mb per subscriber per month
Business
117.49
91.52
160.94
234.03
Residential
111.28
125.85
124.70
139.42
Total
112.04
121.89
128.95
149.23
Business
6152.63
5369.29
7186.92
7900.49
Residential
3959.92
5679.03
7128.70
6469.45
Total
4557.97
5592.33
7143.85
6800.22
Business
2050.88
1789.76
2395.64
2633.50
Residential
1319.97
1893.01
2376.23
2156.48
Total
1519.32
1864.11
2381.28
2266.74
1935.34
1933.78
3026.00
4211.83
Residential
734.50
1111.16
1725.03
2057.45
Total
895.22
1227.78
1916.74
2361.87
Business
645.11
644.59
1008.67
1403.94
Residential
244.83
370.39
575.01
685.82
Total
298.41
409.26
638.91
787.29
Non Dial-up
Mb per subscriber per quarter
Mb per subscriber per month
All Connections
Mb per subscriber per quarter
Business
Mb per subscriber per month
8/11/2006
-63-
Variance 2. Drivers and Determinants of Broadband Uptake
Even if stimulation of broadband uptake is determined to be a substantiated objective as a
consequence of a detailed and informed analysis as recommended in Section 1, the next
question to be addressed is whether the policy tool selected via which to stimulate broadband
uptake will actually be successful in achieving the articulated objective. The Stocktake
authors have concluded, on the basis of the recommendations contained in, principally, the
Network Strategies supporting analysis ‘The broadband divide: achieving a competitive
international ranking’, that the reason for New Zealand’s low broadband uptake is the
relatively low level of competition in New Zealand’s telecommunications markets (“the key
observable difference between New Zealand and the leading countries is the level of
competition” – p i). This is manifested in the low market share of new entrants in the
broadband market, which is deemed to be leading to constraints in the range of products and
prices offered in the New Zealand market (p ii). On this basis, the Stocktake authors have
concluded that the unbundling proposals are essential to increase the level of competition,
thereby increasing the level of broadband uptake in New Zealand.
In the first instance, it is of significant concern that the Network Strategies authors came to
their conclusion that New Zealand’s low uptake is principally the consequence of a
competition ‘problem’ through the use of unscientific and inconsistent analysis
methodologies. The first part of this section discusses the Network Strategies methodology,
and then applies a number of basic statistical analyses on the same data that highlight the
inadequacies of the Stocktake conclusions. That these simple diagnostic analyses were not
performed as a credibility check of the conclusions formed by the ordinal methodology
applied is a significant weakness in the Stocktake analysis process.
The Stocktake conclusions are not only empirically wrong, but at substantial variance with
the conclusions of the substantial amount of theoretical literature that exists on the
determinants of broadband uptake. This literature generally concurs, on the basis of detailed
and sophisticated empirical modelling, that on a macroeconomic level, national income,
population density and the degree of urbanisation of a population are the most important
determinants of a country’s broadband uptake. On a microeconomic level, the literature
identifies that there are a variety of supply and demand characteristics that affect uptake, not
unimportantly the amount of competition that occurs between different broadband platforms,
the price and quality of close substitutes not just for broadband but for other applications,
especially in the leisure market, and the demand for applications that require the capacity of
8/11/2006
-64-
broadband. The second part of the section surveys this literature as a means of identifying
many other reasons why New Zealand might exhibit low broadband uptake.
Despite the wide availability of such literature, the Stocktake analysis process do not appear
to have included any rationality or credibility tests on the Network Strategies findings. A few
simple disconfirming questions (Russo and Schoemaker, 1989), based upon the literature
summarised below, would have exposed the inadequacies. Moreover, the disconfirming
questions should test the assumptions and conclusions from the perspectives of both the
supply side and the demand side of the broadband market.
As the previous section showed, and this section will further elaborate, the validity of many
assumptions underpinning the extent and effect of the Internet and broadband begin to unravel
when compared against data derived from the demand side of the market (for example, the
bandwidth consumption figures in Section 1.6.1.2 above reveal that actual consumption is
many orders of magnitude lower than policy-makers’ projections appear to believe is the real
demand). Thus, it is of especial concern that neither the Stocktake nor the Network Strategies
analyses appear to have considered in detail any potential demand-side explanations for New
Zealand’s low broadband uptake. Indeed, reference to the demand side perspective in the
Stocktake is confined to the comment that “New Zealand users are expressing a strong desire
for faster, better value broadband services” (para 23). The consumer perspective has been
derived not from a detailed scientific analysis (e.g. a focused market analysis) or even a
market research survey, but from “stakeholder inputs to the stocktake process”. As these
inputs had to be self-initiated, they are likely to be subject to substantial self-interest bias, and
so may not be reliable proxies for actual consumer demands and preferences in policy
decision-making.
In summary, therefore, this section will conclude that inadequate analysis has led to a
potentially flawed ‘diagnosis’ that a competition ‘problem’ is responsible for New Zealand’s
low broadband uptake, and that a competition policy ‘remedy’ – unbundling – will be the
‘cure’. Theoretical and empirical analysis reveals that it is highly unlikely that the Stocktake
makes either a correct diagnosis is correct, or prescribes a cure that will be efficacious.
Rather, the evidence suggests that the unbundling proposals may at best have only a marginal
effect upon broadband uptake in New Zealand. They are most unlikely to be the catalyst to
push New Zealand into the top quartile of the OECD in broadband uptake.
8/11/2006
-65-
2.1
The Network Strategies Competition ‘Diagnosis’ Methodology
The Network Strategies authors ‘diagnose’ a competition ‘problem’ by taking the top eight
countries in the OECD by broadband uptake at December 2005 (Iceland, Korea, the
Netherlands, Denmark, Switzerland, Finland, Norway and Canada – that is, the top quartile)
and then comparing them to New Zealand on the basis of a variety of demographic, economic
and competition characteristics (termed general country characteristics, the entry level DSL
services, advanced broadband services, the level of competition and the regulatory
environment). The comparison involved “identifying the key characteristics that distinguish
the top quartile from New Zealand” (Network Strategies, p 4). The acceptance or rejection of
a characteristic being significant was done by ranking the New Zealand statistic alongside the
Top 8 country statistics, and rejecting as a possible explanation any characteristic in which
New Zealand was not at the extreme.
Only if New Zealand ranked 1 or 9 was the
characteristic considered to have explanatory power in respect of the difference between New
Zealand’s broadband uptake and that of the Top 8. No attempt was made to use any cardinal
measures to determine the extent of any metric’s influence upon the actual level of broadband
uptake registered.
2.1.1
Rejection of Country Characteristics
As a result of this methodology, the Network Strategies rejected GDP per capita as being
important, because New Zealand’s GDP per capita exceeded that of Korea, the 2nd-ranked
OECD country. Thus, despite the evidence of the ITU and Figure 1.3 above that very strong
correlations exist between broadband uptake and GDP per capita, GDP per capita was
rejected as an explanation for New Zealand’s performance. As Figure 1.3 illustrates, when
the comparison is undertaken cardinally, using a regression based upon a power relationship,
it is Korea, with its exceptionally level of high broadband uptake, that is the outlier. Thus, the
single most significant determinant of broadband uptake was rejected by Network Strategies,
simply because an exception existed in the top ranked countries (it is well-recognised in the
literature that Korea’s exceptional broadband uptake performance is the consequence of
substantial government intervention in the market – e.g. Wallsten, 2006; Hausman, 2003, and,
surprisingly, even the Network Strategies document itself, on page 20).
Likewise, New Zealand’s small market size was excluded as a possible cause, because
Iceland (1st) had a smaller population15. Population density was also excluded, because
Iceland (very small population) and Canada (8th – very large uninhabited land mass) had
15
Iceland, like Korea, has exhibited exceptional broadband uptake despite many other disadvantages such as small size, distance
from markets and high prices – however, its very high levels of population concentration (almost all Icelanders live in one city –
Rejkavik) has been considered to be important in its high broadband uptake (ITU, 2003).
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lower population densities.
Geographic area was also excluded, because Korea, the
Netherlands (3rd), Denmark (4th) and Switzerland (5th) were smaller, even though each of
these countries has a population density between 9 times and 33 times that of New Zealand.
The degree of urbanisation (based upon World Bank urbanisation data) was also rejected,
because New Zealand exhibited a statistic of 85.9 in this respect, the second highest in the
sample (Iceland exhibited the highest urbanisation statistic). However, the plausibility of
metric must be questioned given that it ranks New Zealand as nearly one third more urban
than the Netherlands (66.3) which has a population density 32.8 times that of New Zealand in
a land area that is only 1/13th of the size16. For Network Strategies to find that New Zealand
is not exceptional in its geography, market size and population distribution relative to the top
8 is astounding, given that it is well recognised that population density, especially large
numbers of people living together in common buildings, substantially reduces the costs of
providing infrastructure and thereby increases availability and consequently uptake (see, for
example, OECD, 2005).
2.1.2
Conditional Rejection of Entry Level Broadband Market Prices
Using a similar methodology with respect to the price and availability of entry level
broadband services, Network Strategies found that New Zealand broadband prices were
neither the lowest nor the highest amongst the nine countries, either as raw dollar
comparisons or accounting for the different income levels by using purchasing power parity
figures. Whilst data caps were cited as a difference relative to unlimited downloading offers
in other countries, these were assessed against theoretical consumption baskets rather than the
actual consumption indicated is likely in section 1.6.1.3 above.
The solitary entry level characteristic considered likely to be influential was a “user
experience that is far less compelling than that available in the leading countries, with the
effect of constraining take-up” as a consequence of the widespread use of data caps (p 10).
No empirical evidence of actual utilisation was offered to support this claim. The importance
of the caps was presumed based upon a hypothetical basket comprising a number of movies,
MP3 files, hours of streaming music web-browsing and online gaming and the number of
email messages and photos that could be exchanged (p9). A 1Gb/month cap comprising a
bundle of one movie, 12 MP3 files, 2 hours of streaming music, 30 hours of web browsing,
16
Whilst the World Bank website does not state the methodology used, the OECD uses at least three ways of classifying urban
populations – by the percentage of the national population that resides in the 10% of regions with the highest concentration of
population largest urban locations, by an ‘urban, rural and intermediate’ classification, and by a weighted index that compares the
economic weight and the geographic weight over all regions in a given country and is constructed to account for both within and
between-country differences in the size of all regions. The index lies between 0 (no concentration) and 1 (maximum
concentration) in all countries and is suitable for international comparisons of geographic concentrationtakes both of these
methods into consideration. By all of these measures, New Zealand ranks close to the OECD average.
http://puck.sourceoecd.org/vl=7307706/cl=18/nw=1/rpsv/factbook/01-01-02.htm
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200 email messages and 10 photos was considered to be “only a limited range of activities”.
The bundles were not benchmarked for plausibility against actual average usage. Neither was
the distribution of bandwidth amongst consumers considered, despite considerable evidence
being available of very skewed demand patterns amongst users (based on a variety of studies,
it appears likely that fewer than 10% of users consume more than 80% of bandwidth – a
figure confirmed in New Zealand circumstances by Howell (2003), and internationally by
PointTopic (2006)). Given the evidence above from Australia in 2005 of average residential
consumption bundles of 2Gb/month, and New Zealand evidence of median usage being
approximately half the average usage, the plausibility of the ‘limited bundle’ assessment is
questionable. New Zealand was also considered an outlier in respect of advanced broadband
services as it had no ‘triple play’ offers, although it was considered that high-quality IP-TV
was unlikely to be implemented in New Zealand due to the high cost of international
backbone capacity (p 11).
2.1.3
Acceptance of Competitive Entry Explanation
Having rejected the aforementioned characteristics as explanations of New Zealand’s
broadband uptake performance, Network Strategies accepted ‘competition’ as the
distinguishing characteristic on the basis that New Zealand was an outlier when comparing
the market share of new entrants in the total broadband market (“one striking characteristic of
all the countries in the OECD top quartile is that the new entrants hold a significant share of
the total broadband market – p 12). This conclusion constitutes the empirical ‘proof’, using
the Network Strategies methodology, subsequently accepted unquestioned by the Stocktake
authors, that the competitive dynamics of the New Zealand market are the ‘cause’ of poor
broadband uptake, and therefore the underpinning justification for unbundling intervention.
At 20%, New Zealand’s new entrant share was lower than the top 8 range (28% in Finland
(6th) to 61% in 5th-ranked Switzerland) at the beginning of 2005, although it was noted that by
the end of 2005, this had risen to 25% (p15).
That low market shares of new entrants is accepted as the ‘cause’ of New Zealand’s low
broadband uptake is astounding, given that cardinally, New Zealand’s measure is only
marginally less than that of 6th-ranked Finland (lowest new entrant share in the top 8), and
that the country with the highest new entrant share is adjacent to Finland in the rankings (5thranked Netherlands). The adjacent ranking of the top-scoring and second-lowest scoring
countries alone should have given some reason to question the robustness of the conclusion
that the market share of new entrants is the defining characteristic of high broadband uptake.
At the very least, the robustness of the conclusion should have been tested with some cardinal
comparisons (e.g. a regression of broadband uptake on new entrant market share). However,
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this was not undertaken. Rather, the analysis accepts this sole “striking characteristic”’ whilst
rejecting others, which have been shown empirically in other studies to have much greater
explanatory power.
2.1.4
Unbundling Characteristics and Methodological Inconsistency
Following the isolation of the entrant market share characteristic, no further tests are reported
to have been conducted, or other national metrics examined. Whilst the state of unbundling
policies in the OECD is tabulated and discussed (p 15-19), this ‘characteristic’ is not ‘tested’
in the same manner as the other characteristics.
The failure to subject the unbundling characteristic to the same test as the other characteristics
is informative about the rigour of the analytical processes.
The failure to apply the
methodology consistently across all identified characteristics means that the unbundling
characteristic, which would have been rejected as insignificant if subject to the test, given that
Switzerland, like New Zealand, has no unbundling in place, is proposed as the ‘solution’ to
the ‘competition’ problem. Even if new entrant market share may have had some explanatory
power, the nexus between competitive entry and unbundling as conjoint effects cannot be
supported as ‘causes’ of high broadband uptake using this methodology.
It is also noted that in addition to not applying their ‘test’ to the unbundling characteristic, the
authors choose this characteristic as the only one for which an explanation for an apparently
anomalous finding within the top-8 countries’ statistics is offered. That an explanation for an
Switzerland’s anomalous high broadband uptake (competition from cable platforms) despite
no unbundling occurring is offered, but none are provided in respect of the other
characteristics (e.g. Korea, despite low GDP; Iceland, despite low population; the effect of
Canada and Iceland’s urbanisation patterns) appears quite inconsistent. If knowledge of a
possible explanation for one inconsistent finding is deemed important enough to be included
for one characteristic, and the reasons for other inconsistencies are widely known (as is
indicated above), then the failure to include such discussions in respect of other
characteristics is puzzling. The failure to include such discussions means that the inadequacy
of the underlying methodology is concealed, and the flawed conclusions more easily accepted
than if the additional information, easily confirmed from a fundamental literature review, was
supplied.
Finally, the unscientific nature of the analysis undertaken is further underlined by the fact that
no cardinal empirical testing was undertaken to support the findings of the ranking-based
characteristic test.
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That no cardinal testing is undertaken to ascertain the materiality of the
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identified characteristic falls well below the standard that would typically be expected both
professionally and academically in such an analysis.
2.1.5
Stocktake Authors’ Acceptance of Network Strategies Findings
Given the demonstrated weaknesses of the Network Strategies methodologies and findings, it
is of concern that the Stocktake authors appear to have accepted the analyses without any
substantial question. The sole evidence of validity checking of the findings comes from the
reference to a European Regulator Group reports and an MFAT cable summarising
discussions with OECD officials.
The Stocktake cites these as “emerging international
evidence … that competition has increased and the uptake of broadband services has
improved following full implementation of LLU” (para 114).
Examination of these
documents (ERG, 2005; MFAT, 2006) reveals that neither offers strong, unequivocal support
for the Network Strategies findings. As will be demonstrated subsequently, the ERG data
actually disprove the existence of a consistently positive relationship between competition on
the local loop and broadband uptake, whilst the MFAT cable authors express significant
concerns about the effect that prices for unbundled elements might have upon industry
dynamics, and hence broadband uptake.
2.2
Regressions Using Network Strategies and Stocktake Data
This section will illustrate how a few simple statistical tests on the data used in the Stocktake
analysis would have drawn into question the efficacy of the ‘competition’ diagnosis and the
‘unbundling’ solution. These simple tests take the metric of interest – broadband uptake – and
using plots and regressions, attempt to determine which characteristic provides the best ‘fit’
using simple models linking the data – measured as the R-squared. The higher the R-squared
value, the better the regression line ‘fits’ the data, and better the predictive nature of the
relationship represented by the line (note that this does not necessarily prove causation, but
simply captures which model is ‘best’ at predicting the broadband uptake of a country with
the given level of the independent variable in question).
2.2.1
GDP per Capita
As has already been illustrated in Figure 1.3, the power relationship offers a relatively good
predictive model of the link between GDP per capital and broadband uptake (R-squared of
0.58).
This implies that rejection of this characteristic was fundamentally flawed. The
outliers using this relationship are Korea (unusually high broadband uptake), Luxembourg
(very high GDP per capita) and Ireland (very low broadband uptake given its high GDP, due
to exceptional economic growth in the 1990s).
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If these three ‘exceptional’ countries are
removed from the analysis, the R-squared for the remaining 27 countries rises to 0.74).
Thus, the nexus between GDP and broadband diffusion is very strong. As New Zealand’s
position in Figure 1.3 is so close to the predicted relationship, it is very difficult to exclude
this characteristic as the key variable. Even if the relationship is plotted as a linear one
(Figure 2.1), the position of New Zealand is still consistent with the model, even though the
fit is this case is substantially less good than the power relationship (R-squared is 0.36).
Figure 2.1
Broadband Uptake per Capita and GDP per Capita – Linear Relationship
70,000
GDP Per Capita, USD, PPP
60,000
Ireland
New
Zealand
Luxembourg
y = 752.76x + 16801
50,000
R2 = 0.3551
40,000
30,000
Korea
20,000
10,000
0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Broadband Penetration per 100
2.2.2
Population Distribution
Whilst intuitively, population density would appear to offer some plausible explanations for
broadband uptake, some difficulties occur because of the large land masses and relatively
small populations of countries such as Iceland, Australia and Canada.
The degree of
urbanisation probably provides a more plausible correlate, given that infrastructure is less
costly, and therefore more likely to be provided, in areas of high urbanisation. One would
expect more urban societies to have higher broadband uptake, simply because the services are
more likely to be deployed in areas where large numbers can access them.
However, as discussed above, the World Bank urbanisation statistics used by Network
Strategies seem a little implausible when comparing the OECD countries. Indeed, when
plotting broadband uptake on these data, the linear relationship is poor (R-squared is 0.13).
An alternative urbanisation statistic is provided by the OECD, which classifies populations as
urban, intermediate and rural. Using this measure, a weak positive relationship is found (R-
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squared is 0.21) between the percentage of urban population and broadband uptake – Figure
2.2.
Figure 2.2
Broadband Uptake and Urbanisation
y = 15.924x + 7.1279
R2 = 0.2077
Broadband Penetration per 100
30.0
25.0
20.0
15.0
New
Zealand
10.0
5.0
0.0
0%
20%
40%
60%
80%
100%
% Population Urban (OECD)
Figure 2.2 suggests that a more consistent positive relationship between urbanisation and
broadband uptake exists among countries with a higher level of urbanisation. If the sample is
split in two, between those countries exhibiting urbanisation levels higher than 40% (as per
the vertical dotted line in the graph) and those lower, the linear fit improves substantially for
the higher-urban countries – R squared is 0.42, and the positive coefficient increases from
15.9 to 27.6. The relationship between broadband uptake and urbanisation in the group with
OECD urbanisation percentages less than 40% is slightly negative, with a very poor fit – Rsquared is less than 0.01.
This finding suggests that the connection between urbanisation and broadband uptake is more
significant in the OECD countries with more urban populations, but that other characteristics
may be influencing the high broadband uptake of a handful of low-urban countries. The lowurban/high-uptake OECD countries are Denmark, France, Finland, Austria and Sweden (all
are above the OECD average for GDP per capita); the low urban/low-uptake countries are
Greece, Turkey, Ireland, Poland, Hungary, the Czech Republic and the Slovak Republic (with
the exception of Ireland, these are all lower-quintile in GDP per capita).
This finding
suggests that it is possible that the relationship between GDP and broadband uptake is more
significant in explaining broadband uptake in low-urban countries than among high-urban
ones. It is noted that New Zealand’s position close to the (arbitrary) 40% cutoff point for this
analysis, means that its broadband uptake may be affected jointly by these effects – that is, as
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a nearly low-urban and low GDP-per capita country, it may be more strongly influenced by
the GDP effect.
If the Stocktake methodology was applied in reverse to find the characteristics linking the low
broadband uptake countries, Figures 2.1 and 2.2 tend towards the conclusion that their
common characteristics are their low GDP (only Ireland has a higher GDP and lower
broadband uptake than New Zealand – Figure 2.1) and their low levels of urbanisation (only
Mexico has a higher level of urbanisation and a lower broadband uptake than New Zealand –
Figure 2.2).
2.2.3
New Entrant Market Share
Given that country characteristics appear to offer some very plausible, statistically-supported
indications that the factors rejected by the Stocktake are in fact likely explanators of
differences in broadband uptake across the OECD countries, it is now informative to compare
the strength and the nature of the relationship between the factor that is found to be significant
– the share of broadband connections sold by ‘new entrants’. Network Strategies’ ‘new
entrant’ shares are actually the market shares of all broadband connections sold by anyone
other than the incumbent telecommunications company. Thus, it is presumed that they
include cable, wireless, satellite, mobile and Ethernet LAN connections, as well as DSL
connections sold on entrants’ own network infrastructure and incumbent-facilitated services
sold by entrants under wholesale, bitstream and unbundling arrangements.
Figure 2.3 plots the data as provided by Network Strategies on p 13. Plotting a straight line
indicates a positive relationship (that is, a 10% increase in the percentage of broadband
connections sold by new entrants is associated with an increase of 1.6 broadband connections
per 100), but the relationship is not a strong one (R-squared only 0.2). Thus, new entrant
market share is slightly less good as a predictor of broadband uptake than the OECD
urbanisation percentage taken over the entire OECD data set (R-squared = 0.21). However, it
is a substantially less good predictor of broadband uptake than either the linear (R-squared =
0.36) or power (R-squared = 0.58) relationships based upon GDP per capita. These findings
confirm that the rejection of both GDP per capita and population density-based metrics by
Network Strategies, in favour of the new entrant/competition explanation, is materially flawed
as a conclusion. At least two of their rejected characteristics show better potential as a
predictor of broadband uptake than their “striking characteristic”.
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Figure 2.3
Network Strategies: New Entrant Market Share and Broadband Uptake
30
y = 0.1632x + 7.6385
Broadband Penetration per 100 Population
R 2 = 0.2
25
20
15
10
5
0
0
10
20
30
40
50
60
70
80
New Entrant Market Share %
Moreover, on the basis of this regression relationship, it does not appear likely that a simple
increase in the market share of new entrants in the New Zealand market will be sufficient to
take New Zealand to the top quartile of the OECD broadband uptake. An increase in new
entrant market share to 50% (i.e. dividing the market equally between Telecom and all other
broadband providers) would increase New Zealand’s uptake to only 12.9 connections per
hundred by this relationship. That would move New Zealand up into only 18th place (one
behind Australia) in the December 2005 rankings. Even if 100% of connections sold by new
entrants (assuming that this is a plausible scenario) would fail to elevate New Zealand into the
top quartile, as the resulting uptake would be 20.9 per hundred, ranking New Zealand at only
9th place, between Canada and Sweden. This finding highlights the implausibility of the
Stocktake authors’ beliefs that changes in competition policy alone will be sufficient to
achieve the equally implausible top quartile ranking towards which the policy is directed.
Rather, this finding suggests that, at best, changes to competition policy are likely to have
only a very small effect upon broadband uptake.
Further doubt is cast upon the likely effect of competition in the local loop on broadband
uptake when alternative models are applied to the Network Strategies data. Figure 2.4 plots a
quadratic curve on the same data as Figure 2.3. The quadratic model shows that a much
better fit (R-squared = 0.39 – nearly twice as good as the linear model). This regression
suggests that there is an ‘optimal’ level of new entry – that is, ‘too much’ competition may
actually lead to decreases in broadband uptake. Interestingly, this model shows the ‘optimal’
amount of new entrant share is around 50%. Countries with new entrant market shares past
this point actually decreasing levels of broadband uptake.
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Figure 2.4
Network Strategies New Entrant Market Share: Quadratic Curve
Broadband Penetration per 100 Population
30
25
20
15
10
y = -0.0061x2 + 0.6058x + 2.4707
R 2 = 0.3856
5
0
0
10
20
30
40
50
60
70
80
New Entrant Market Share %
What Figure 2.4 is capturing is the already well-established finding in the theoretical and
empirical literature that it is the extent of competition between infrastructures that offers the
best explanations amongst those associated with competition for differences between national
broadband uptakes (Maldoom and Sidak, 2003, 2004; Howell, 2002; OECD, 2005 amongst
others) (recognising that GDP per capita is still the characteristic that has the strongest
explanatory power). This is illustrated by plotting the 2005 OECD non-DSL market shares
against broadband uptake.
Figure 2.5
OECD Non-DSL Market Share and Broadband Uptake
Broadmand Penetration per 100
30.0
y = -113.2x 2 + 84.012x + 2.295
R2 = 0.4657
25.0
20.0
15.0
10.0
5.0
0.0
0%
10%
20%
30%
40%
50%
60%
70%
80%
Non-DSL Market Share %
Figure 2.5 shows that the quadratic curve on this data exhibits gives an even better fit (Rsquared = 0.47) than the new entrant plot in Figure 2.6, and an ‘optimum’ level of non-DSL
market share of around 40%.
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That is, it is not who sells the broadband technology
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(incumbent telco, new entrant using wholesale, bitstream or unbundling or alternative
infrastructure provider) that matters most in the link to broadband uptake – what matters most
is that different technology platforms are competing with each other. This finding is not
surprising – as early as 2001, the OECD and others were advocating that competition between
infrastructures was the ideal objective, and that unbundling policies were only meant to be
stepping stone measures aimed towards facilitating long-term objectives of competing
platforms (the ‘ladder of investment’ unbundling approach is predicated upon this stepping
stone theory – Shelanski, 2002).
2.2.4
Comparison with European Regulator Group Data
Thus, it is apposite to test the strength of the ‘evidence’ offered by the Stocktake authors that
unbundling is correlated with higher levels of broadband penetration in the European Union,
as claimed to be reported by the European Regulators Group (ERG, 2005). Figure 2.6 shows,
that the Stocktake authors claims of emerging evidence supporting the role of unbundling in
stimulating broadband uptake from this report is factually incorrect. The European data show
both a substantially less positive effect of new entrants market share than the OECD data (the
coefficient is 0.0095, compared to 0.16), and a substantially less good fit of the curve (Rsquared is 0.0011, as opposed to 0.2).
Indeed, the extent of the linear relationship is
sufficiently weak enough to support a reasonably confident conclusion that no statistically
significant linear relationship at all exists between new entrant market share and broadband
uptake in the European Union.
Figure 2.6
ERG New Entrant Market Share and Broadband Uptake
Boradband Peneteation per 100 Population
25
20
15
y = 0.0095x + 9.4054
R2 = 0.0011
10
5
0
0
20
40
60
80
100
120
Market Share New Entrants - ERG Septem ber 2005
Rather, as Figure 2.7 shows, the same pattern of an ‘optimum’ level of entry is exhibited in
the EU data as in the OECD data. That is, there are limits to the extent of the effect of new
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entrant presence upon broadband uptake.
Again, just as with the OECD data set, the
quadratic relationship on the ERG data shows both a better fit (R-squared is 0.3) and an
‘optimum’ level of new entry of around 50% market share.
Figure 2.7
ERG New Entrant Market Share and Broadband Uptake: Quadratic
Boradband Peneteation per 100 Population
25
y = -0.0048x 2 + 0.4746x + 0.1055
R2 = 0.302
20
15
10
5
0
0
20
40
60
80
100
120
-5
Market Share New Entrants - ERG Septem ber 2005
Furthermore, Figure 2.8 shows that, if anything, extensive unbundling on incumbents’ DSL
networks in Europe has actually had a slightly negative (although not statistically significant)
effect upon the numbers of DSL connections per 100 population.
Whilst the fit is not
especially good (R-squared is 0.01), the coefficient is negative (-0.024). That is, a 10%
increase in the number of new entrants entering the DSL market by this model (almost all of
which has occurred via wholesaling, bitstreaming and unbundling) leads to a decrease of 0.24
per 100 in DSL penetration.
Figure 2.8
ERG New DSL Entrant Market Share and DSL Uptake
DSL Penetration per 100 Population
20
18
16
14
12
10
y = -0.0238x + 8.1417
R2 = 0.01
8
6
4
2
0
0
20
40
60
80
100
ERG DSL New Entrant Market Share, September 2005
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120
The effect that Figure 2.8 is most likely capturing is the depressing effect on broadband
uptake that arises from new entry occurring on the DSL platforms of incumbents rather than
on competing infrastructures. The single characteristic that separates the EU countries from
the rest of the OECD is the very large shares of broadband uptake growth that have occurred
on DSL. By comparison, the market shares of other broadband technologies in countries such
as Canada and the United States have been much more even, although DSL market share
passed that of other technologies in the United States in 2005 (PointTopic, 2005). Likewise,
in countries such as Korea, even though two companies provide DSL, they do so via
competing networks. The distinguishing factor in Europe is that DSL new entrants are almost
always utilising the incumbents’ infrastructures at least to some extent, and that DSL has had
much larger market shares in most EU countries since at least 2002-3.
It is further noted that, far from exhibiting increasing levels of broadband uptake in concert
with increased LLU across time, the European data have consistently shown no compelling
statistical evidence of any statistically significant relationship. Analysis of a similar type to
that undertaken herein was performed by Criterion Economics in European Union data in
2003.
The analysis in this study, and the conclusions drawn by its authors, shows a
remarkably similar set of relationships to those above.
Specifically, inter-platform competition appeared to be the best competition-based predictor
of broadband uptake in 2003, with an ‘optimum’ level of competition occurring at a point of
approximately 45% non-DSL market share (Figure 2.9 – source Criterion, 2003: 114,
compared with Figure 2.7). Moreover, in 2003 no statistically significant relationship was
evident between the non-incumbent sellers of DSL and broadband uptake (Figure 2.10 –
source Criterion, 2003: 117 compared with Figure 2.6). Furthermore, the Criterion authors
found no significant relationships either between the percentage of broadband subscribers
buying bitstream and resold broadband lines and broadband uptake, or even between
unbundled lines and broadband uptake (p 118). Rather, they came to the conclusion that the
European evidence in 2003 tended to support the contention that resale, bitstream and
unbundling may be occurring at the expense of investment in competing platforms (Figure
2.11 – source Criterion, 2003: 121). The evidence from the 2005 ERG report tends to suggest
that no substantial changes have occurred in the intervening two years. Altogether, these
findings suggest that there is very little empirical substance to the claim that European Union
unbundling policies have been responsible for the increasing levels of broadband uptake
exhibited in these countries, or that the effect of unbundling is becoming more significant
across time.
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Figure 2.9
Criterion Broadband Penetration and Platform Competition, 2003
Figure 2.10 Criterion Broadband Penetration and Non-Incumbent DSL Access, 2003
Figure 2.11 Criterion Take-up of LLU/Line Sharing/Bitstream/Resale, 2003
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2.3
Confirmation of Exploratory Data Findings via Literature Review
Section 2.2 illustrates that the validity of the Network Strategies analysis and conclusions are
of highly questionable validity, and the Stocktake authors acceptance of these findings at face
value without further checking the credibility of the conclusions in the published, peer
reviewed literature on the factors linked with broadband uptake suggests poor research
process management. Even a very cursory examination of the literature confirms that there
are likely many factors contributing together to create the circumstances in which broadband
uptake occurs, and a great deal of uncertainty as to what the relevant factors might be.
Moreover, it is far from certain that the drivers are confined to supply-side characteristics
(“the paucity of robust estimates on the drivers of demand and supply is remarkable, given the
amount of discussion expended on the topic” – Chaudhuri and Flamm, 2005:1).
Attempting to explain the complex dynamics with a single metric, therefore, as attempted in
the Stocktake, is highly unlikely to lead to a tractable relationship. It would appear that, even
within a range of metrics that are associated with broadband uptake, competition is likely
substantially less important that other factors such as GDP per capita and geographic
circumstances, and that within the likely competition explanations, the effect of LLU
(including wholesaling and bitstream) is at best highly ambiguous, and at worst either
irrelevant or possibly even negative. Whilst the availability of services provides a constraint,
there is considerable evidence of consumers who could purchase broadband choosing instead
to purchase dial-up Internet access. Chaudhuri and Flamm (2005:5-6) provide evidence
United States evidence of areas where broadband is available to 80% of households where
fewer than 15% subscribe.
Neither is it clear that simple individual or household
demographic data are sufficient to explain the differences in uptake. Both Rappoport et al.,
(2002) and Chaudhuri and Flamm (2005) conclude that the demographic differences between
dial-up and broadband users are not significant.
Thus, any explanation of the ‘drivers’ of broadband uptake are likely to be based upon a large
number of interacting variables, not the least of which are factors relating to the demand side
of the market. Thus, it is not surprising to find that it is nearly impossible to explain
differences using a single metric on the supply side of the market. Indeed, given the inability
to find a consistent, multivariate explanation using supply-side characteristics, and the paucity
of studies examining the effects of either demand side characteristics, or the interaction of the
two, it may well be that demand-side factors are the most significant influences.
For
example, Haring, Rohlfs and Shooson (2002:26) observe “we would put our chips on demand
rather than supply constraints, and on the relative paucity of applications being the main
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‘culprits’ restraining take-up” in a variety of countries, including the United States (Ferguson,
2002; Hundt, 2002). This conclusion is supported empirically by a case study by Howell
(2003) in the New Zealand context, that low broadband uptake exists despite the presence of
six competing infrastructures, widespread availability of at least three of the technologies,
internationally low prices, especially given that the small amounts of data transported mean
that data caps are unlikely to be a significant brake, and a very experienced, heavy Internetusing population base with wide acceptance of use of the Internet for a wide range of
activities.
2.3.1
Multivariate Analyses
In the first instance, a study of the literature shows that, whilst only a few multivariate
analyses have been undertaken, most come to the conclusion that there is little evidence
supporting the role of unbundling policies per se on broadband uptake. Rather, income and
geographic circumstances are by far the most statistically significant factors, with competition
factors being less significant than both of these, and the competition characteristic that
matters most is inter-platform competition rather than intra-platform competition.
A review of the literature confirms that, from both theoretical and empirical analyses, there is
a remarkable degree of consistency in these findings. Wallsten (2006) offers the most
comprehensive and most recent summary of the published studies. In his words (p 3):
“The literature reaches some broadly consistent conclusions, though some countries
or regions are exceptions to these general results. First, as one would expect,
population density is a strong predictor of broadband penetration since more densely
populated areas are less costly to serve. Second, competition across platforms (i.e.
facilities-based competition) strongly affects penetration. Access competition (i.e.
reselling another firm’s services via unbundling laws) does not generally seem to
have a positive effect, though many may disagree with that conclusion. Third, no
particular government policy has been empirically shown to have a strong positive
impact on penetration”.
Rather than repeat Wallsten’s review, it is noted that he surveyed 38 pieces of analysis in
reaching his summary. Of these, twelve included detailed empirical studies of a scientifically
robust statistical nature, and thus form a base which can be reliably assumed can be used
confidently for the purposes of policy-making. The balance of the papers which do not
include detailed statistical analyses are predominantly the work of academics or subject
specialists affiliated with research institutions, regulatory authorities and policy ‘think tanks’.
Reliance upon academic credibility offers some assurances that the studies that the papers
report were motivated by intellectual endeavour rather than the furthering of vested interests.
Whilst many are too new to have been yet published in the academic literature, the authors are
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almost all affiliated with organisations whose academic credibility would be substantially
harmed by the publication of biased, unsubstantiated, misleading theories and results, or
results arrived at via academically unsound processes.
2.3.1.1 Geography, Income and Inter-Platform Competition Significant
The key take-out from Wallsten’s review is that, along with income and population
characteristics, competition across platforms is significant in all studies. This finding is
robust within countries (e.g. the United States – Denni and Gruber, 2005)), across regions
(e.g. Europe – Distaso, Lupi and Manenti, 2004)17 and the OECD (e.g. Ismail and Wu, 2003;
Maldoom, Marsden, Sidak and Singer, 2003). However, Wallsten can find no consistent
findings in respect of government policies and broadband uptake generally.
Indeed,
empirical analyses on United States data generally show that few state-level policies have had
any effect at all on broadband uptake (e.g. Flamm, 2005; Wallsten, 2006a).
Whilst unbundling policies have been the most extensively adopted regulatory tools, despite
much theoretical discussion about their ability to stimulate inter-platform competition by
enabling competitors to successively invest in their own infrastructures across time (Cave,
2006), the empirical evidence is quite inconclusive about their effect. Generally, empirical
studies find no significant relationships.
Evidence supporting unbundling is typically
confined to case studies rather than detailed empirical testing (e.g. Frieden, 2004, comparing
Canada, Japan, Korea and the United States).
Whilst there is general agreement that
unbundling in the United States reduced incentives to invest in high-speed Internet
infrastructure, there is an absence of empirical literature assessing the relative effects of
different forms of unbundling upon infrastructure investment (Wallsten, 2006:7).
2.3.1.2 But Little Evidence that Unbundling is Significant
The consistency of the empirical studies is instructive. Hausman and Sidak (2004), comparing
the United States, the United Kingdom, New Zealand, Canada and Germany, find no
empirical support for the “four rationales” of unbundling – that lower retail price/product
variety competition is desirable; that retail competition cannot be achieved without
unbundling; that ‘stepping stone’ investment leads to facilities-based competition; and that
competition in wholesale markets is desirable. Hazlett (2005) finds that removal of linesharing regulations (an unbundling element) was associated with increases in broadband
17
Interestingly, the Stocktake authors cite this paper in their list of references (page 32). Thus they must have been aware that
the key finding of this paper, based upon European Union evidence, was that “the econometric evidence confirms the results of
the theoretical model and indicates that while inter-platform competition drives broadband adoption, competition in the market
for DSL services does not play a significant role” (abstract – my emphasis). That such a finding from the only econometric
paper referenced by the authors was not commented upon in the body of the report draws into further question the calibre of the
analysis and reporting process undertaken.
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uptake in the United States. All of Maldoom et al. (2003), Garcia-Murillo et al. (2003); Aron
and Burnstein (2003), and Distaso et al. (2004) find no statistically significant effect of
unbundling on broadband uptake. Only Ford and Spiwak (2004) find statistically significant
evidence supporting the existence of a positive correlation, in this case between the regulated
rates for unbundled loops and the share of zip codes in a state with a certain number of
broadband providers.
However, Aron and Burnstein (2003), investigating the same
relationship using a different model controlling for more effects than Ford and Spiwak, came
to a different conclusion. As it is difficult to ascertain how Ford and Spiwak constructed their
data set, replicating their study is difficult (Wallsten, 2006:6). Thus, it would be dangerous to
put too much credence in the findings of this study given the much larger number of studies,
where the methodology is clearly articulated and replicatable, find no statistically significant
effect from unbundling,.
In part to address the inconclusiveness of the empirical evidence, Wallsten conducts his own
empirical analysis using OECD data. His study is unique in the literature in that it not only
considers unbundling generally, but tests for the effects of different unbundling policies (local
loop, bitstream, sub-loop). His study is also unique in that it controls for the year that
unbundling was introduced, other country fixed effects (thereby eliminating differences in
population density, income, number of telephone lines etc) and the effects of wholesale price
regulation and co-location price regulation. In this respect, it is the most comprehensive
empirical analysis that this author has seen. In addition, Wallsten also uses his data to
establish whether unbundling regulations have had any effect upon the speeds of broadband
offered in countries with unbundling – a key issue given the importance placed upon the
‘ladder of investment’ theory.
2.3.1.3 Unbundling is Sometimes Negatively Correlated with Broadband Uptake
Wallsten finds conflicting and ambiguous effects from different forms of unbundling policies.
Unsurprisingly, he finds that population density is significantly correlated with both
broadband uptake and broadband speeds (p 16).
He finds no statistically significant
relationship between any form of unbundling and the broadband speeds offered. However,
with regard to regulations, “some appear to be beneficial while others are harmful”. He finds:
1.
Full local loop unbundling is not consistently correlated with broadband
penetration – in some specifications it is positive and significant, in others it is
negative and significant and in others again it is not significant at all;
2.
Sub-loop unbundling (that is, entrants placing their own equipment in remote
cabinets rather than exchanges) is robustly negatively correlated with broadband
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penetration across all specifications – that is, it leads to lower levels of broadband
penetration than when it is not present in all of the models Wallsten specifies;
3.
Co-mingling co-location is generally positively correlated, virtual co-location is
negatively correlated, and regulated prices for co-location are negatively
correlated with broadband penetration. That is, the effect upon broadband uptake
is positive only when incumbents and entrants agree prices by mutual contract.
Wallsten concludes that sub-loop unbundling is negatively correlated because it gives new
entrants the greatest relative advantages and incumbents the greatest obligations. He suggests
that the negative effect upon incumbents is the dominant effect in suppressing incumbent
investment in broadband infrastructures (as evidenced in the United States). The negative
correlation with regulated co-location prices is, he suggests, a consequence of regulators
setting co-location prices below cost, thereby further depressing incumbents’ incentives to
invest. Hence, regulated co-location prices are correlated with slowing the rate of broadband
uptake. On the other hand, he suggests that alternative co-location rules might mitigate the
problem, citing the example of Japan. Thus, the OECD’s example of regulated prices below
cost being associated with increased investment in Japan (MFAT, 2006) may not be a result
of the prices themselves, but the ways in which the rules relating to co-location are applied.
On the point of co-mingled versus virtual co-location, Wallsten suggests that as co-mingled
co-location is the least expensive way for competitors to enter the market, it is likely that this
explains the faster deployment and uptake in countries where this option was mandated than
in countries where virtual co-location was required (more expensive, as entrants have to
house their own equipment).
In sum, Wallsten suggests that his findings are empirically consistent with the theory that
“regulations that can reduce returns to investment (more extensive unbundling) or increase
costs to entrants (allowing incumbents to insist on off-site co-location) reduce broadband
investment. In other words, market rules that keep costs low but allow firms to earn returns
on investment are good for broadband growth” (p 17).
2.3.2
Demand-Side Explanations and the New Zealand Data
However, Wallsten acknowledges that the supply-side factors on their own are insufficient to
account for all the differences in broadband uptake. Consistent with Haring et al. (2002),
Howell (2003), Howell and Obren (2002), Flamm, (2005), Chaudhuri and Flamm (2005),
Crandall (2004), Faulhauber (2002), Hausman, Sidak and Singer (2001) and Varian (2002),
Wallsten identifies that prices to the consumer matter significantly in the broadband uptake
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equation. All of these authors have identified the role played by dial-up Internet access prices
in the decision to move to broadband, especially in countries where Internet diffusion is
widespread.
As Howell and Obren (2002) illustrate, if broadband is only conditionally
dominant as a frontier technology, then the diffusion rates may be slower in countries with
widespread dial-up diffusion than in countries where there are larger numbers of new internet
users entering the market. This is because, whilst new Internet users may purchase the
frontier, existing users will migrate only when the cost-benefit equation for doing so is
positive.
Where there is not only extensive dial-up diffusion, but a substantially less
compelling economic case for switching (as occurs in those countries with ‘free’ local
residential telephony), the decision to substitute will occur proportionately later.
2.3.2.1 Prices and Availability of Substitute Internet Connections
In this respect, the findings of Horrigan (2006) in the United States, and the price
comparisons in Howell (2003) provide some compelling evidence consistent with Chaudhuri
and Flamm’s (2005) finding that dial-up and broadband are imperfect substitutes for each
other, with lower prices for dial-up being correlated with lower demand for broadband.
Indeed, Chaudhuri and Flamm found in the United States that whilst the actual price for
broadband services was significant in the decision to adopt, its very small coefficient
suggested that in practice, the price does not matter very much, and that household income
has approximately the same effect on stimulating dial-up Internet access as it does on
broadband access (p 19).
However, they find that the degree of urbanisation was an
important determinant of the type of Internet access purchased.
Whilst there was no
geographic distinction in uptake of dial-up, urbanisation was a factor for broadband. This
finding is consistent with that of Goldfarb and Prince (2006), that the technological nature of
dial-up facilitates remote and concentrated equipment provision, whereas broadband requires
more extensive local deployment of equipment.
Thus, the rate at which broadband is
deployed, and the areas in which it is made available, creates barriers to uptake, whereas there
are no such geographic barriers to dial-up adoption, as modem banks can be installed
anywhere the ISP chooses.
Chaudhuri and Flamm’s findings suggest that, rather than the absolute price of the service, it
is the relative price, given utilisation patterns that matters most. In Australia, New Zealand
and the United States, unmetered local telephony for residential users was typical, and
associated with higher Internet connection and usage (OECD, 2000). Dial-up internet was
widely diffused in all three (most extensively per capita in New Zealand – Boles de Boer
Enright and Evans, 2000; the State of e-New Zealand – all editions). Howell (2003:42) found
that the ratio of broadband to dial-up prices on a purchasing power parity basis for residential
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users in 2003 was highest in New Zealand (between 1.51 and 2.59, depending upon the
broadband plan chosen), not because broadband prices were high (indeed, they were low by
international standards in the benchmarking for this report), but because the prices for dialup were comparatively lower than those in the other OECD countries benchmarked (for
example, the United States ratio was 1.28).
Thus, if Chaudhuri and Flamm find a significant correlation between low dial-up prices and
low broadband uptake in the United States (to which, incidentally Hausmann and Sidak
(2004), Wallsten (2006) and Flamm (2005) all attribute the United States’ fall in the OECD
rankings from 4th to 12th between 2002 and 2005, despite strong positive growth in the
number of broadband connections), then it is most likely that the effect would be even greater
in New Zealand (note that Howell (2003) attributes the absence of an uptake problem in New
Zealand businesses is because the ratio of business broadband to dial-up is substantially less
than one for most plans).
Whilst it has been suggested by some that dial-up is not a
satisfactory substitute for broadband, it is noted that, despite the growth of broadband, new
dial-up connections still continue to be sold in the United States (Horrigan, 2006 finds only
half of new United States Internet users purchase broadband connections). As long as the
broadband:dial-up price ratio exceeds one, and usage levels remain low in the absence of
compelling applications that are unable to be provided on dial-up, there will be users who will
find dial-up the economically rational technology choice. Lowering the price of broadband
services will influence the change only to the extent that doing so leads to positive benefits
for the users. If the application base does not change, then broadband prices must fall to less
than dial-up prices to induce these users to substitute. This analysis presumes that the value
of time savings from broadband is relatively small, given the small volumes of data
transferred. Furthermore, consistent with Varian (2002), leisure time may be valued more
lowly by residential consumers than business consumers, simply because it is not explicitly
priced.
Despite lower broadband prices, New Zealand’s broadband uptake has not accelerated to the
extent that has been evidenced in European countries, most likely because the dial-up price
remains lower than the broadband price in all cases. As a response to the pressure from
decreasing broadband prices in New Zealand, dial-up prices have fallen as well. A quick
check in July 2006 of the major ISPs showed that all still maintained a broadband:dial-up
price ratio substantially greater than one (range for entry-level products (500Mb/month) was
still between 1.2 and 1.8 for unlimited dial-up hours per month, with the ratio rising to 2 if the
customer also bought toll services from the ISP. The ratio was as high as 3 for a light (20
hours/month) dial-up user. By comparison, the ratio for the same number of dial-up hours
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from Australian provider Bigpond was 1.5 using prepaid hours or 2 on a 12-month contract
(noting that Bigpond applies megabyte caps for downloading for dial-up consumers as well as
broadband, as well as a 5-hour session timeout). A check of the BT website revealed no
offers at all for dial-up Internet access. The comparison for Orange revealed at the entry level
the unlimited dial-up to low-end broadband ratio was 1, meaning consumers would be
indifferent on price, but derive greater benefit simply from broadband speed, making a dial-up
purchase actually less valuable, all other factors held constant. Thus, despite substantial
broadband price falls, and lower prices both in nominal and PPP terms for broadband, large
margins still exist between dial-up and broadband in New Zealand relative to Australia and
the UK. Thus, the relative disadvantage broadband versus low-priced dial-up in New Zealand
is very substantial, and is not reducing across time.
2.3.2.2 Application Bases
In the absence of any compelling price-based reasons, another reason for New Zealand dialup users to substitute will be application-based. If there is evidence, as suggested by Haring
et al. and Variation 1 discussions above that the application base does not provide a
sufficiently compelling justification for users to pay the higher broadband prices, then dial-up
will remain the dominant form of Internet access. As the discussion above indicates, this is
not necessarily a negative effect – indeed, over-much switching in the face of the high
differentials in price indicated above would actually be inefficient, as individuals would be
paying more than they valued the benefits at. It is thus important to examine the applications
used in New Zealand, and the price, availability and substitutes offered, especially in the
leisure/residential market.
As indicated by Howell (2003), supported by the data from Australia in Table 1.4, median
and average bandwidth demand is actually quite low. This suggests that the bandwidthintensive residential entertainment applications of video and audio streaming, and gaming, are
not highly-valued in the New Zealand market, relative to the alternatives. Korean data
(National Computerization Agency, 2005) indicates very high demand for high-bandwidth
applications such as gaming (54% of users rated it their second most important use of the
Internet after email) and Budde (2006) records 28,000 gaming parlours and three cable
television channels devoted exclusively to gaming in Korea. By contrast, email and browsing
rate as the most important New Zealand applications, with gaming much lower down the
order of priorities (State of E-New Zealand) – a ranking similar to the United States, where
Horrigan (2006) finds that only one third of Internet users had ever played on-line games at
all.
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Furthermore, if video-based entertainment is considered an important determinant of
broadband uptake in the future it is important to compare the prices and availability to close
substitutes. In a market where all entertainment is converging on a digital format, the ways in
which, particularly, television content is distributed becomes important.
New Zealand
exhibits very widespread uptake of pay television, with 38% of households subscribing to a
single provider, SkyTV18, with the vast majority receiving digital satellite transmission. This
service enables a certain extent of pay-per-view television, along with a mail-based DVD
rental service. Table 2.1 shows that at 33 channels, Sky offers a similar service to other pay
TV services across the OECD. The service is the third-cheapest satellite service offered (out
of 31), and the 17th cheapest pay TV service (out of 64), and is available to 100% of the
population. Thus, substitute video-based entertainment is already widely available, highlysubscribed, and low-priced by OECD standards. The demand for alternative forms of video
entertainment may therefore be low in New Zealand depressing the value to consumers of
internet-based entertainment options.
Likewise, New Zealand is well-served with radio
stations (ITU, 2006), further depressing demand for audio streaming.
Moreover, Howell (2003) makes the further argument that the wide range of leisure activities
available in New Zealand compared to other countries means that very high-speed, highcapacity broadband-based entertainment may be competing for household spending in a very
crowded leisure market. If households prioritise other entertainment over home-based video
entertainment (e.g. skiing, boating, playing sport, walking on an isolated beach), then there is
a lower demand for such entertainment in the first place. This does not mean that welfare is
harmed by the absence of broadband uptake – to the contrary, welfare is increased because
individuals are engaging in the activities from which they derive the greatest satisfaction. To
the contrary, Howell suggests that the high uptake of broadband in Korea may be a reflection
of the shortage of other leisure applications, with total welfare actually potentially being
lower – that is, a Korean playing a video game might prefer to be walking on an isolated
beach, but settles for the lower-welfare video game simply because walking on an isolated
beach is too costly or not an option that is available in the market. In this instance, New
Zealanders may benefit from having greater choice and the ability to access leisure options
not available elsewhere (a similar argument might also attend the high uptake of video
entertainment in the Nordic countries, especially in winter months, where outdoor activities
are limited by light and weather conditions).
18
http://www.skytv.co.nz/index.cfm?pageid=459
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An interesting finding in respect to the adoption and usage patterns in residential markets is
that of Goldfarb and Prince (2006), who find that although the wealthy are more likely to
purchase broadband connections, the amount of use is negatively correlated with income. If
it is presumed that leisure activities dominate broadband usage, their finding is consistent
with the lower values of welfare being derived from Internet-based applications than other
leisure applications. Firstly, those with lower incomes may have more time available to
consume entertainment (consistent with other statistics associated with television viewing).
Secondly, if those facing less of an income constraint are choosing other leisure activities
more often than Internet-based entertainment, this must be because they are deriving greater
benefit from the non-Internet activities. Once again, this finding suggests caution should be
applied when attributing a value to the welfare associated with broadband connections. It is
not at all clear that Internet-based leisure activities are unquestionably more valuable than
others, raising questions about the value of stimulating their uptake on the presumption that
the welfare associated with these activities is somehow ‘better’ than welfare associated with
other leisure activities.
2.3.2.3 The Business Adoption Effect
Whilst the previous section considers only the residential application base, it is apposite to
also consider the effect of business applications not just upon the number of broadband
connections purchased, but the effects of business demand upon the decisions about the
location of broadband equipment. Goldfarb and Forman (2005) find substantial differences in
the likelihood of different businesses to adopt ICTs, based upon the industry sector in which
they participate, the size of the business, the degree of vertical integration, and their physical
location. Whilst firms in the government, FIRE (finance, insurance and real estate) and
manufacturing sectors are high users, agriculture and forestry are low users. The dominance
of agriculture and forestry in New Zealand, and the relatively low reliance upon FIRE firms,
may have a depressing effect on New Zealand’s uptake. Moreover, firms that are more global
are more likely to adopt e-commerce applications, as are vertically dis-integrated firms, and
larger firms are more likely to adopt than smaller ones. Notably, “small firms rarely adopt
complex technologies such as e-commerce” (p 17). However, as noted above, substitutes
such as TradeMe may be quite satisfactory substitutes in a small, dispersed market such as
New Zealand, with over 99% of its firms in the international SME category. As has been
noted above, TradeMe has been designed not to require large quantities of bandwidth.
Also significant in the role of business adoption is Forman, Goldfarb and Greenstein’s (2006)
study of the location of investment in broadband technologies. They found that the presence
of high ICT-using United States businesses was correlated to the choice of
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telecommunications providers to locate broadband equipment in a locality. However, they
also found no evidence of investment by competitive infrastructure in localities where fewer
than 100,000 individuals resided, without the use of state government incentives, irrespective
of the nature of the business conducted in these localities. This characteristic provided an
added disadvantage for rural businesses, and led to their conclusion that agglomeration
matters for the supply of broadband services, irrespective of the demand characteristics.
Hence, absence of a significant numbers of large communities, the small size of businesses,
and the larger share of agriculture and forestry in the New Zealand business base may be
affecting not just the uptake of broadband, but also the patterns of supply.
2.4
Summary
The analysis and literature survey in this section leads to the conclusion that it is very difficult
to place a high degree of confidence in the findings of the Stocktake authors and Network
Strategies that competition factors are the ‘cause’ of New Zealand’s low broadband uptake, or
that unbundling is a ‘solution’. The inadequacy of the analysis undertaken means there are
very real risks that a decision made on the basis of this information will be flawed, and
therefore highly costly. There is no substantial evidence to suggest that, aside from the
universally recognised income and country characteristics, New Zealand’s broadband uptake
is abnormally low. Moreover, there is no empirically substantiated evidence that increasing
the level of competition in the market will have anything other than a marginal effect.
Moreover, the empirical evidence from Wallsten (2006) suggests that not only will
unbundling be unlikely to have a consistently positive effect upon broadband uptake, there are
actually some potentially negative effects that have been correlated, across the OECD, from
adopting some of the forms of unbundling recommended in the Bill.
At the very least, this evidence suggests that a substantial amount of review and
reconsideration is required to the Bill, especially in respect of the extent of recommendations
to adopt sub-loop unbundling and virtual collocation, which are almost sure, by Wallsten’s
study, to lead to negative effects on the rate of broadband uptake. Given the flaws in the
process and conclusions of both the Stocktake authors and Network Strategies, it would
appear that a full review of the entire proposal is indicated, as the lack of rigour and
consistency in the analysis suggests that the proposals, as they stand, are highly flawed and
likely highly costly, at least in respect of New Zealand’s broadband uptake rate.
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Table 2.1
Pay Television Services in the OECD
Premium cable service
Total terrestrial
FTA channels
available
Number
of
channels
Monthly fee
(USD)
Number of
channels
Monthly
fee
(USD)
Number
of
channels
63.60
130
63.60
130
none
none
..
..
..
..
..
8
9.00
35
..
..
..
..
3
39.80
56
..
..
..
..
5
Austria
Belgium
(Flemish)
Belgium (French)
4
Czech Republic
Denmark
Finland
9
2
6
4 plus “a number
of local
channels”
13
1
50.0
83
60.70
120
..
..
34.70
37
45.40
177
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
France
Germany
29
48.30
28
Greece
21
..
..
Hungary
DTT subscription
service
Monthly fee
(USD)
Australia
Canada
Premium satellite service
7
29.50
48.30
60.70
1
28
24
..
32.60
..
1
3
53
54.80
45 plus many
free channels
(total at least
100)
16
68.50
129
69.10
86
..
..
Iceland
Ireland
4
20.20
1
25 plus “several
local channels”
51.70
30
61.80
67 (plus some
FTA channels)
..
..
Japan
7
..
..
51.60
62
..
..
Korea
5
14.30
78
74.77
193 (including
audio, data
channels)
..
..
Luxembourg
3
13.50 (Eltrona)
52
..
..
..
..
Mexico
13
39.40
122
47.40
..
..
Netherlands
7
32.60
60
59.60
40.20
24
New Zealand
8
18.60
39
43.60
..
..
Norway
10
28.10
41
56.40
more than 175
32 channels
plus “around
180 free
international
channels”
33 (may
include some
radio)
35
..
..
Poland
7
..
..
..
..
..
..
Portugal
4
92.30
53
89.20
44
..
..
Slovak Republic
4
10.10
43
19.70
more than 100
..
..
Spain
10
(with Internet
and telephony)
55
56.00
62
..
..
Sweden
8
89.00
43
37.00
37
45.50
23
Switzerland
2
80
..
..
..
..
45
..
..
..
..
Italy
3
17.20
4.70
1
1
Turkey
4
United Kingdom
32
..
..
..
..
..
..
United States
22
49.00
120
77.99
more than 180
..
..
Note: Connection fees not included.
1. Basic service
2. Data from www.broadcastdialogue.com
3. Data from EAO 2003
Source: OECD Communications Outlook 2005, Table 7.8
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Variance 3: Unbundling and Investment in Broadband Infrastructure
Given that there is no substantiated empirical evidence to support the use of unbundling as a
tool to increase broadband uptake, then if the Bill is to proceed, it would be expected that
there must be other strong evidence that it would be of net benefit, despite the potential
negative effects it may have upon broadband uptake. In this respect, the Stocktake authors
claim to have ‘evidence’ that the absence of strong, industry-specific regulation has led to a
lowering of investment in the core infrastructure by Telecom. Their bases for such a claim
are the finding from Azimuth that Telecom’s investment plans for the Next Generation
Network have slipped by one year, and the comparative investment summary provided by
Network Strategies (Network Strategies, 2006b). Their ‘evidence’ that unbundling will lead
to increases in investment in the entire sector is based upon their reliance upon the ‘ladder of
investment’ model utilised by the European Union (ERG, 2005; Stocktake, Annex 2), selfreported providers’ statements of their future investment plans with and without unbundling
(Network Strategies, 2006b: 2-40), and the assertions by OECD officials communicated via
the MFAT cable that incumbents and new entrants invest more under unbundling than
without it.
In the first instance, it must be questioned whether more investment in broadband technology
is actually welfare-enhancing in the first instance. The absence of any empirical analysis in
this respect means that this question is not even addressed in the Stocktake. Such a question
requires detailed analysis of the costs, prices and consumer valuations of broadband and the
alternatives, and must be measured against a relevant counterfactual.
If regulatory
intervention induces higher investment in technologies that are more expensive than
substitutes, then total welfare will decrease. Indeed, the costly losses associated with the
‘dot.com crash’ provide illustrations of such welfare losses associated by over-much and
over-early investment in infrastructure that remained under- or unutilised.
The extent to which the New Zealand investment situation represents one of underinvestment
is highly debatable, and is accorded a full section in this report, as once again, it appears that
the methodology used to analyse the situation falls short of sound and robust academic and
professional practice. The current section will survey the international theoretical and
empirical literature about the veracity of the claims made that unbundling drives investment.
In summary, there is substantial theoretical and empirical evidence that, rather than increasing
the level of investment in broadband technologies, it appears that the strategic incentives
facing both incumbents and entrants are biased towards constraining investment relative to
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the counterfactual of no unbundling. It is noted, however, that different applications of
unbundling policies will lead to different incentives, and hence relative differences in the
investment patterns observed. Whilst isolated examples of behaviour contrary to the strategic
incentives might exist (for example, the case cited by the OECD in the MFAT cable of new
investment occurring despite unbundling access prices being set below cost), there is
nonetheless a large body of empirical and case study evidence confirming the presence of
delays in the implementation of technologies by incumbents, and a skewing of investment
towards the telecommunications platforms of incumbents, at the expense of investment in
competing platforms. Investment delays appear to be most significant when there is greater
uncertainty about the likely market outcomes of an innovative technology such as broadband,
or when the regulatory environment is itself uncertain. The evidence of distorted investment
patterns under uncertainty is best illustrated by the investment patterns of the 1990s, leading
up to the dot-com crash in 2001-2.
Furthermore, the incentives to invest are crucially dependent upon the prices set for access to
regulated services.
Setting prices too low has been shown unequivocally to depress
investment in the United States. Moreover, even if prices are, by chance, set appropriately, it
is not at all clear how this might affect the investment incentives of those market participants
who have already invested in competing platforms. Lowering their investment risks by
allowing them to invest in unbundled elements may result in them abandoning development
of competing infrastructures, to the long-term detriment of the very competing platforms that
have been shown (above) to be correlated with higher broadband adoption.
This section, therefore, casts substantial doubt upon the Stocktake authors’ belief that
unbundling will stimulate increased investment in broadband infrastructure in the New
Zealand context. Rather, it serves to reinforce the cautions expressed by the authors of the
MFAT cable that the OECD’s “somewhat cavalier attitude” towards the “investment
incentives associated with regulated network access” “needs further testing” (p 7).
Importantly, this section reiterates that the prices set by regulators are crucial in the setting of
incentives, the uncertainties associated with predicting the future of uncertain new
technologies is large, and that regulators may not be best-placed to determine the course of
investment in uncertain and unproven technologies. That the Stocktake authors appear to
have taken few steps to test these assumptions, but have rather appeared to rely upon the
advocacy of others, provides further cause for concern about the efficacy of their unbundling
recommendations.
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3.1
Unbundling History and Broadband Technologies
It is apposite at this point to consider why unbundling was introduced in most jurisdictions in
the first place. Its principal purpose was to facilitate competition for incumbents providing
“plain old telephone systems” (POTS), and as such was usefully employed across the 1990s
as a safeguard against abuse of market power when many formerly state-owned telephony
providers were privatised (Appendix 1 contains a teaching note provided for MBA students
about unbundling history).
Thus, its core purpose was to stimulate competition on
infrastructures that were mostly mature, fully-diffused “natural monopolies” – that is, POTS
services over copper loops, where the sunk costs were sufficiently high that there was no
realistic expectation that an alternative provider would build a duplicate infrastructure.
That unbundling is now subject to examination in markets for the provision of very immature,
relatively lowly-diffused technologies such as broadband, and is implicated in different
investment and diffusion rates achieved in these new markets is one of accident rather than
design. In this regard, unbundling’s effect is neither theoretically justified nor empirically
tested. Rather, what is occurring is a ‘natural experiment’ where many of the effects in
specific circumstances are being observed and theorised against a variety of counterfactuals
derived from different market conditions and different ways in which unbundling policies
have been applied.
Key to analysing these case studies is the recognition that, as a
consequence of rapid technological development, many of the core assumptions that led to the
introduction of unbundling policies no longer hold. In particular, it is by no means certain
that the natural monopolies that telecommunications companies enjoyed in the POTS markets
pertain in broadband markets. Hence, the need to stimulate competition on the local loop may
be rendered redundant by the much more powerful effects of competition from other
technological platforms.
It is this finding that explains much of the empirical evidence
discussed in Variance 2 above that inter-platform competition is the dominant competition
effect driving broadband diffusion.
3.1.1
Convergence and Competition
The advent of widespread digitisation (see discussion in Variance 1 above) and rapid
technological advances in ICTs have led to rapidly decreasing costs of new ICT-based
equipment over which POTS and other digitised information transfer can be provided. A
wide variety of technologies now enable the provision of digitised information exchange.
Importantly, extant technologies such as cable television, which already had widespread
networks in the ‘last mile’ of connectivity, especially to residential customers, have resulted
in copper wires no longer constituting the sole means of transferring digital information
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between locations.
Whilst convergence has occurred in the medium to which information is
encoded (digital form), it is by no means axiomatic that this will result in convergence upon a
single technology via which all digital information exchange will occur. Thus, the historic
‘mindset’ of telecommunications companies being natural monopolies simply because of their
ownership of the copper wires no longer applies with respect to digital information transfer.
In fact, rather than convergence upon a single technology, the opposite has occurred as a
consequence of widespread digitisation. The number of technologies over which digital data
can be exchanged has increased, and now includes fire-optic cable, wireless, mobile
telephony, satellite, Ethernet LAN, and undoubtedly different technologies into the future
(e.g. WiMAX). Moreover, rather than concentrating all of their digital communications on a
single connection, businesses and households are increasingly purchasing a multiple number
of connections, depending upon the features of the applications supported by the different
infrastructures. Hence, we see households with mobile and land line telephony connections,
and multiple pay and free-to-air television connections, in order to benefit from the different
applications that each offers. Furthermore, it is by no means clear that connecting locations is
paramount in the digital information exchange environment. As illustrated by the widespread
diffusion of mobile telephony, connecting individuals, irrespective of location, confers value
that many individuals are prepared to pay a premium to obtain.
Rather, the competitive landscape has tended towards convergence upon a single retailer
managing the interface between a customer of information transfer services and the
infrastructures on which they are supplied. Thus, the trend has been towards a ‘triple play’
where a single firm will bill a customer for all of voice, video and Internet services, even
though they may be provided on different infrastructures (e.g. mobile, fixed line and satellite
as evidenced in New Zealand, where both Telecom and TelstraClear onsell and bill SkyTV
subscriptions). Thus, convergence in the retail space has been upon convergence to a single
customer relationship, at the same time as convergence onto a digital medium has actually
increased the number of infrastructures on which the data can be and is transported. This
distinction between the two types of convergence is informative for competition purposes, as
the convergence upon a single customer relationship invokes considerations of vertical and
horizontal integration in the supply chain, either by ownership or contractual alliance, in order
to facilitate the provision of a single point of billing, at the same time as infrastructure
competition becomes potentially even greater.
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3.1.2
Mobile Competition and Diffusion
The diffusion of mobile telephony provides a good example of how a new technology
competing with the incumbent POTS, achieved rapid diffusion in most markets relatively
unimpeded by regulatory intervention. Shelanski (2002) notes that the diffusion of mobile
telephony provides a very good counterfactual for thinking about the likely effects of
regulation in broadband markets. Regulation was not required to stimulate the diffusion of
this technology – rather, competition between technological platforms (e.g. GSM, CDMA)
stimulated not just widespread diffusion, but competition based upon the different
technological capabilities and qualities of the different technologies. This led to faster levels
of innovation, as each sought to replicate the desirable (successful) features offered by the
other, and further differentiate their offerings from competitors. It is notable that it was not
considered necessary to impose regulations requiring owners of mobile infrastructures to be
subject to competition from new entrants on their own networks whilst the technology was
diffusing – inter-platform competition was deemed a sufficient discipline.
The effect of inter-platform competition in mobile telephony has been sufficient to lead to the
point where, in the OECD economies at least, the number of fixed plus mobile lines per capita
across the OECD is sufficiently large to suggest that most individuals have access to both
(OECD, 2005), and there is evidence of individuals no longer maintaining a fixed line
telephony connection as other options such as mobile are perfect substitutes. For most
purposes, this would constitute a finding of the two telephony services being very close
substitutes, able to impose cost and service quality disciplines upon each other, and therefore
reducing the need for overt industry-specific regulation in voice telephony. This is not,
however, intended to negate the importance of combined market power where the otherwisecompeting networks have common ownership. However, this is more properly an issue for
competition law than industry-specific regulation, as the same issues attend common
ownership in all industries, whereas not all industries have the high sunk cost structures of
telecommunications firms.
3.1.3
Why Persist With Industry-Specific Regulation?
Unbundling as a tool to discipline incumbent telecommunications companies, at least in
respect of POTS services, thus appears to have little justification where there is extensive
provision of other technologies. Therefore, it begs the question of whether there is any
justification to persist with unbundling at all, let alone in respect of the markets for digitised
information exchange, where competition is already present from mobile telephony services,
cable television in many jurisdictions, and is likely to be even greater in the future as new
technologies such as wireless and satellite are further developed.
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In the United States, the FCC decided in 2004 that it was appropriate to redefine the relevant
market as ‘information exchange’ rather than ‘telecommunications’, and subsequently many
of the extensive requirements upon incumbent telecommunications companies in respect of
broadband service provision were removed (FCC, 2005). However, the FCC has been alone
in the OECD in taking such a stand. A view prevails in some jurisdictions (including those in
the EU) that there are still economies of scale in the provision of broadband that imply
markets may be oligopolistic, and may tend towards duopoly or even monopoly in areas with
small population (Chaudhuri and Flamm, 2005:3). That is, incumbents may be able to offer
the new products on their existing platforms at lower average cost per connection than new
entrants, so may engage in anti-competitive behaviour (principally, utilising their existing cost
advantages to undercut new entrants’ prices, thereby preventing new entrants from providing
competing services on their own platforms).
Where two platforms exist, then common
ownership or even tacit collusion may enable incumbents with different technologies (e.g.
cable and copper) to act jointly to deter new entrants.
The possibility of incumbents engaging in anticompetitive behaviour has been used to support
ongoing regulatory intervention in telecommunications markets. However, this regulation has
mostly been applied in a one-sided manner, most likely as a consequence of the legacy of
extensive regulation in telecommunications markets. Thus, telecommunications providers of
broadband tend to be subject to regulation, but not the providers of new technologies (e.g.
wireless, mobile, satellite, and Ethernet LAN services) or even cable television providers
(Hausman, 2002).
3.2
Theories of Unbundling and Investment
The presence of asymmetric regulations and different regulatory regimes in different
countries has therefore enabled a ‘natural experiment’ to be conducted upon the effects of
regulations upon incentives to invest in broadband. The outcome is a substantial body of
theory and empirical evidence explaining the behaviour of investors in regulated and
unregulated environments when the investment relates not to a fully-diffused, mature natural
monopoly technology, but a new, unproven technology capable of being provided on a variety
of platforms, but where incumbent providers might have a natural advantage in their existing
investments, which could affect the ways in which investment and competition occur in the
provision of the new technology.
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3.2.1
The ‘Ladder of Investment’
The bodies of literature that have emerged tend to fall into two distinct groups. The first
body, based around the ‘ladder of investment’ theory (Cave, 2006; Cave, 2004) utilised
predominantly in Europe, is based upon the presumption that, even though competition may
exist from other platforms (notably cable), the principles of encouraging investment by new
entrants in those aspects of the incumbent’s service provision that are not subject to natural
monopoly will still be positive. By allowing incumbents to install their own equipment
alongside that of incumbents, a greater degree of product variation on the copper network will
ensue than if all copper-based product differentiation was provided only by the incumbent
facing competition from facilities-based providers. New entrants therefore can build up both
their own customer base which is presumed to provide greater certainty of an ongoing market
for services and thereby increased incentives for entrants to invest in their own infrastructure.
These incentives are presumed to lead to increases the total amount invested on the copper
infrastructure, relative to the counterfactual of only the incumbent investing. New entrant
investments are made gradually, beginning with from wholesaling and bitstreaming, leading
to incentives to invest in IP network equipment, backhaul capacity, exchange-based
equipment (DSLAMs) (full unbundling), and eventually, via sub-loop unbundling, local
DSLAMs and fibre-optic connections close to customer locations.
To date, there is little evidence of new entrants progressing to building full stand-alone
networks based upon an unbundling entry strategy. Rather, entrants have tended to invest in
elements of their own infrastructure in densely-populated areas, and augment these
connections with wholesaled or bitstream connections from the incumbent in areas where it is
infeasible to invest in their own infrastructure (Foreman, Goldfarb and Greenstein, 2005).
Most new entry is targeted initially at business customers, as the greatest profit margins exist
in these markets (Foreman and Goldfarb, 2005).
A mixture of unbundled,
wholesaled/bitstream and own infrastructure services is predicated largely upon a business
strategy of one information transportation company providing all services to all branches of a
single firm, wherever those branches may be located. Thus, based upon the need to present a
‘single face’ to customers, new entrants (including those with completely separate
infrastructures (e.g. wireless, fibre) tend to utilise unbundled loops for at least some parts of
services to some of their customers. The benefit to the end customer is predicated upon a
transaction cost saving from dealing with only one firm. The benefit to the firm packaging
the mix of services is control of the customer relationship. The alternative would see the
customer exposed to competing offers from many firms, depending upon the technology types
via which the service is provided. Thus, competition for business customers in unbundled
markets typically hinges upon ‘all or nothing’ bids to provide a comprehensive package of
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services to business customers. Business contracts are thus typically long-term agreements
(e.g. one year is common, but longer (e.g. two year) contracts are not unusual).
However, as Cave (2006) indicates, successful application of the ladder requires a detailed
knowledge of which elements are genuinely natural monopolies, and therefore ones where it
will never be efficient for an entrant to duplicate existing infrastructure, and in which
elements infrastructure investment is desirable, and therefore should be the subject of
incentives to encourage new entrants to invest. The key to successful ‘ladders’ is to provide
sufficient incentives to each entrant to invest in the first place, and then continue to
successively invest in the next level (rung of the ladder), up to the point where (if at all) a
natural monopoly element is encountered. To this end, the ‘ladder’ will be successful in
stimulating the efficient level of investment only if it is not presumed that unbundling is an
end in itself.
Rather, it succeeds by stimulating competing investment in stand-alone
infrastructures by increasing the prices of unbundled elements across time and utilising sunset
clauses to ensure entrants do not presume unbundling to be a long-term investment strategy.
Given the conceptual foundations of the ‘ladder of investment’, it is difficult to understand
why, where competing cable and infrastructures exist, unbundling would be required at all.
Presumably, if competing infrastructures have been invested in, this is because there are no
natural monopoly elements in the ‘last mile’ – duplication is economically feasible, as
evidenced by the duplication of the full infrastructure by facilities-based entrants. To this
end, it must be remembered that ‘duplication’ is not necessarily duplication of fibres or wires,
but duplication of a mechanism via which to exchange digitised information. Thus, wireless
or cellular technologies offer duplication of the ‘last mile’ copper-based telecommunications
services, just as cable infrastructures do. The requirement for incumbents to unbundle, when
already facing competition from alternative infrastructures, would seem to offer little
additional benefit, aside from, perhaps, increasing the range of products available on copper
technologies, or acting as a brake upon the ability of incumbents to act oligopolistically.
Even then it is difficult to understand why, if invoked, it should apply to the owners of only
one technology (telecommunications) but not the others (cable). The most likely explanation
for the uneven application of the obligations is that the pattern of application is not the
outcome of principled implementation, but rather the consequence of a history of
telecommunications unbundling but not cable unbundling.
3.2.1.1 Application in Canada
To date, the success of the ‘Ladder of Investment’ theories are largely unproven, as they are
seldom applied in the principled manner advocated by Cave (2006). The most convincing
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evidence that there is some substance comes from Canada (OECD, 2003:36-37). Canada,
which introduced unbundling in 1996, is one of the few countries where cable broadband
connections continue to exceed DSL. Canada has consistently been a top ‘performer’ in
respect of broadband uptake and prices. Canadian unbundling regulation has been one of the
most ‘technology-neutral’ forms of the policy applied in the OECD, and has been predicated
upon a clearly articulated long-term objective of vibrant inter-platform competition.
Firstly, in Canada, incumbents were not required to make unbundled elements available
where alternative networks were present, or where the regulator deemed it was feasible for
new entrants to reasonably deploy their own infrastructure. This is credited with providing
strong incentives for entrants with their own infrastructure to continue investing on their
existing platforms, rather than relying upon access to unbundled elements from incumbents to
grow their market share. Furthermore, different prices were charged for unbundled elements
in different locations, reflecting the different costs, and therefore the different investment
decisions to be made about installing equipment in different locations.
Importantly, this “geographically de-averaged” pricing structure enabled incumbents to
respond to new entrants based upon the actual costs of servicing different areas (thus, they
could match prices in urban localities as they did not have to use revenues from artificially
high urban services to cross-subsidise rural locations), preserving the typical competitive
behaviour that occurs in markets whenever a new entrant challenges an incumbent who has
been charging a price higher than cost. The result is that the welfare gains from entry are
conferred immediately upon consumers in the low-cost areas (although this does create an
‘equity’ issue for rural consumers, in that ‘de-averaged’ pricing regimes lead to them paying
the full cost of services rather than a subsidised cost – for a discussion of geographic deaveraging and the effects upon entry decisions, see Appendix 2 – an MBA teaching note on
the investment incentives associated with ‘averaged’ or ‘universal’ pricing).
Moreover, Canada initially instituted a five-year ‘sunset clause’, signalling an expectation that
new entrants would be expected to have their own infrastructures within five years. However,
this clause was subsequently removed. Indeed, it is these differences between Canadian and
United States approaches to unbundling that have been credited with the very different prices,
behaviour and consumer uptake in the two countries (Flamm, 2005).
Consequently, the Canadian investment patterns are interesting. At the end of 2001, around
4% of Canadian telecommunication loops were unbundled (OECD, 2003:20) (at this time,
5.5% of US loops were unbundled, and New Zealand had around 4% of its POTS lines
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provided in stand-alone infrastructures – mainly Saturn, subsequently TelstraClear).
Following the dot-com crash, the number more than halved (OECD, 2005:59), suggesting that
the number of new entrants reduced as a consequence of having invested in their own
infrastructures as well as unbundled loops, with the financial pressures of the crash requiring
them to exit the market. It is interesting to note that Canada is the only country to record a
decrease in unbundled loops between 2001 and 2002. This would be consistent with the
theories, discussed subsequently, about the allocation of financial risk under unbundling being
disproportionately borne by incumbents. As only Canada provided strong incentives for
incumbents to invest in their own equipment, it is not surprising to find that Canada was the
only country to record a reduction in unbundling when infrastructure owners, but not renters,
were subject to financial pressure. The demise of infrastructure owners in the ‘dot.com crash’
simply recognises that these entrants had to bear financial risks that are borne by the
incumbent in unbundling.
Given that strong inter-platform competition still appears to be the driving force behind
expansion of the broadband market in Canada, and that competing investment has been
achieved without substantial recourse to unbundled loops, it is not clear that the Canadian
investment patterns are a ‘success’ for the ladder per se – rather, they may be a success
because of the limitations placed upon entrants utilising the ladder for an ‘easy entry option’
in lieu of making substantial investments in their own stand-alone infrastructures. It is noted,
however, that Canada’s investment levels have been achieved in a country which, despite its
low population density, is extremely urban in nature. Thus, it cannot be discounted that the
degree of urbanisation means that there were very few natural monopoly elements, and that
investment patterns were naturally predisposed towards duplication in the first place. In that
case, the ladder has been applied efficiently, given that there was already a large cable
presence in the market.
3.2.1.2 Application in Germany
By contrast, Germany, which also introduced unbundling 1996 (implemented in 1998), has
been heralded as the unbundling leader in Europe (OECD, 2001; 2003). By 2001, only 1.6%
of loops had been unbundled.
Following the ‘dot.com crash’, unbundled loops sold in
Germany accelerated rapidly, reaching just over 3% of all loops by 2003, still short of the 4%
of loops sold by New Zealand new entrants in 2001. Whilst Cave (2006:229) cites higher
numbers of unbundled loops in Germany than the OECD figures (“60% of all unbundled
loops in Europe”), including very large increases post 2003, it appears that his numbers most
probably include bitstream as well as fully-unbundled loops.
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Thus, it is not clear exactly how much additional investment has actually occurred. As the
OECD numbers are recorded on the basis of investment in equipment, the discrepancy tends
to suggest that the level of investment by new entrants in Germany might actually be quite
small, with competitive entry being based around a significant reliance upon bitstreaming,
which implies most entrants are on the very lowest ‘rungs’ of the ladder. This is confirmed
by data from German regulator RegTP’s annual reports. Table 3.1, taken from the 2003
annual report, indicates that by 2002, some five years after unbundling began, 90% of new
entrants were using the incumbent’s (DTAG’s) infrastructure, with only 0.44% of lines being
provided entirely on competitor infrastructure.
Table 3.1
Competitor Investment in Germany: 1998-2002
Unlike Canada, Germany has had negligible cable infrastructure to compete with
telecommunications in broadband or telephony markets (OECD, 2003). In this instance, it
could have been expected that the ladder might have had significant potential to stimulate
substantial competitive entry from infrastructure investment.
If the OECD numbers are
credible, the evidence does not appear to support robust alternative investment as occurred in
Canada. It is also interesting to note that, despite the extensive new entrant presence in
Germany, broadband uptake remains poor (18th in the OECD at December 2005). Indeed,
Germany’s ‘plunge’ in the OECD league tables between 2001 and 2005 (from 11th to 18th)
despite the surge in unbundling has been more spectacular than New Zealand’s. Moreover,
New Zealand’s broadband uptake growth rate in the period December 2003-June 2004, prior
to any effects of the 2003-4 bitstream regulations introduced in New Zealand in mid 2004,
was twice that of Germany’s (OECD, 2005 Table 5.7).
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3.2.1.3 Application in the United States
The key distinction between unbundling as it was applied in the United States, relative to
Canada, is that United States incumbents were required to provide access to new entrants at
less than cost (most services were required to be provided at 50-60% less than retail price –
Cave, 2006:227). This policy has been implicated with a substantial lack of incentives to
invest in competing infrastructures in this market. These findings are confirmed by FCC data
(Figure 3.1) reported in 2003 (FCC, 2003), which show substantial increases in the use of
incumbent investments (UNEs and Resold Lines), whilst additional investment in competitor
infrastructure ceased (CLEC-owned lines plateaued in 2001).
Figure 3.1
United States Line Ownership, Unbundling and Resale 1997-2002
20,000
Lines (thousand)
18,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
Resold Lines
Total UNEs
Total UNEs and Resold Lines
CLEC-owned Lines
Dec-02
Jun-02
Sep-02
Mar-02
Dec-01
Sep-01
Jun-01
Mar-01
Dec-00
Sep-00
Jun-00
Mar-00
Dec-99
Jun-99
Sep-99
Mar-99
Dec-98
Sep-98
Jun-98
Mar-98
Dec-97
0
Cave (2006) has likened the United States situation as the ladder operating in reverse, as the
obligations upon new entrants to invest in their own infrastructure became substantially less
arduous across time. Thus, it is not surprising to find that, unlike Canada, unbundled loops
were very extensively utilised for bitstreaming, but with limited investment in actual
infrastructure, in all areas, including those where replication was both feasible and present.
Indeed, more than half of all lines were sold under bitstream arrangements, with half of these
supplied to two companies: WorldCom and AT&T.
Whilst the short-term benefit of these policies was lower retail prices, the negative
consequence was a lack of investment in competing infrastructure by the new entrants using
the local loop. Inappropriate application of regulation was thus implicated in a reduction in
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investment in the sector.
Hazlett (2005) notes that cable companies, whose broadband
services were largely unregulated, invested more quickly in their infrastructures than the
regulated telecommunications companies, despite the investment requirements that
incumbents were made to meet for bitstream services based upon their unbundled customers’
projected demands.
The United States FCC, based upon detailed empirical evidence of the negative effects of
unbundling regulations on investment, ended mandatory line-sharing requirements in 2003,
and in 2004 provided guarantees that broadband providers will not be required to share their
new investments with competitors (FCC, 2005). Following these announcements, Hazlett
(2005) notes that substantial new investments were made in high-speed ‘fibre to the home’
(e.g. Verizon’s FiOS fibre optic cable). Broadband uptake accelerated rapidly following the
removal of these restrictions.
3.2.2
Uncertainty, Options and Investment Incentive Depression
Clearly, when prices and investment incentives are inappropriately applied, there is no
disagreement between the ‘ladder of investment’ and the ‘uncertainty and options’ schools of
thought that unbundling will be associated with reductions in investment. As has been
illustrated above, the reduced incentives are both theoretically present and empirically
measurable.
Thus, there are considerable documented costs associated with applying
unbundling inappropriately, and to date no documented, quantifiable evidence that the ‘ladder
of investment; actually works in practice.
A second set of theories developed from the ‘failed’ applications of LLU suggest that
unbundling is associated not just with depressed incentives to invest in competing platforms
given the current state of technology, but also with distortion in investment across
technologies and across time, because it leads to a different allocation of the risks associated
with deploying new, unproven technologies in markets where there is substantial uncertainty
about the outcomes of such investments. In these circumstances, a new entrant can obtain a
‘free option’ by leasing the new services provided by the incumbent at regulated prices.
When expensive new technology is unproven, there is a risk that it will be deployed, and then
demand will fail to materialise. If the costs are unrecoverable (i.e. ‘sunk’), then the firm is
left with ‘stranded assets’, and makes a substantial loss.
Arguably, given the relatively
unproven nature of demand for future high-speed broadband products, these products may
come into this category. If an incumbent is required to make available, via the regulated
unbundling requirements, any investments in new technologies to new entrants at regulated
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prices that do not include a margin to account for the uncertainty of the technology’s future
success, then the incumbent may decide not to invest at all. The new technology is therefore
provided by no-one. As regulators are no better at predicting the likely outcome of an
uncertain new technology than any one else, the prices that they set may be influenced by
other desires, such as low prices in order to appease entrants, or to speed up the diffusion of
the new technology, and therefore fail to include a reasonable premium for the uncertainty. If
the technology is successful, then incumbents do not receive a fair return for the financial
risks they have borne. If, on the other hand, the technology fails in the market, then the
incumbent bears all the losses. The new entrants, who own no infrastructure, can costlessly
exit the market. That is, they have a ‘free option’ conferred by the ability to compete without
having to invest in infrastructure (Bittlingmeyer and Hazlett, 2002; Crandall, Ingraham and
Singer, 2003; Crandall and Hausman 2000).
The effects of the ‘free option’ are graphically illustrated by the United States regulations and
the dot-com crash of 2001-2. Incumbents were required, often with substantial lead-in times,
to supply services anticipated to be required by new entrants, especially for bitstream and
wholesale orders. In particular, this included substantial investments in fibre and DSLAMs.
The more customers serviced by new entrants, the less reliable the incumbents estimates
became in respect of future investment requirements. Rather, they were forced to rely upon
the estimates from their ‘downstream’ customers, the new entrants, for capacity projections.
If the entrants got the demand projections ‘wrong’ on the high side, then far too much
capacity would be installed. This is precisely what occurred with the two largest new entrants
WorldCom and AT&T. Incumbents were forced to invest in capacity to meet the demands of
these customers, whose inflated over-estimates of their own customers’ demands led to their
financial demise. Projected orders, and the associated cash-flows did not materialise, but the
incumbents were left with substantial unused capacity, and in financial distress themselves,
whilst the new entrants were able to avail themselves of the provisions of bankruptcy laws.
By contrast, it is noted that Telecom New Zealand, as one of the few companies not obliged
to offer unbundled services, came through the 2001-2 ‘crash’ with one of the strongest
balance sheets of all OECD telcos, a fact that Merrill Lynch (2003) attributes to the fact that
Telecom had not over-invested in capacity to the same extent as incumbents in other
jurisdictions.
Thus, absence of unbundling, and the extent to which these policies expose
incumbents’ investment plans to the vagaries of entrants’ demand projections, has measurable
benefit in the presence of entrant estimates that are overly optimistic.
By extension,
unbundling ‘success’ would appear to rely critically upon the accuracy of the future demand
assessments of a large number of entrants. Whilst more projections being made will increase
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the probability of at least one of them being near to correct, the requirement that the
incumbent underwrite all of the risks associated with the accuracy of all of the projections
actually increases the risks borne by the incumbent’s shareholders. To cover this risk, the
incumbent will be required to provide a higher return on capital to shareholders under
unbundling than when unbundling is not required (Crandall, Ingraham and Singer, 2003;
Eisner and Lehman, 2001). Hence, the prices of unbundled elements might realistically be
higher when sold to entrants than to the incumbent’s own retail arms, in order to account for
the additional demand projection risks.
Given that incumbents are aware of the ability of regulators to set prices that unevenly
allocate the risk of new investments, by requiring the sharing of the benefits of successful
investments with entrants, but bear the full costs of any unsuccessful investments if it is
feasible that a regulator will mandate unbundling of new investments, the incumbent may
actually decide to defer investment in new technologies until there is greater certainty that the
new technology will be successful (Dixit and Pindyck, 1995). Thus, it is likely that new
technologies will be invested in later than if the risks and returns were borne solely by the
incumbent. The flip side to this argument is that, if new entrants can gain access to a new
technology via the regulator, at no risk to their own capital, they will overwhelmingly prefer
unbundling to own investment. Thus, even though new entrants can invest, they choose not
to, preferring rather to seek regulatory intervention forcing the incumbent to invest first. Both
incumbent and new entrants thus defer investing. End consumers bear the costs, as they
cannot use the technologies at all until they are installed.
Hence, the ‘free option’ school of thought agrees that it is appropriate that entrants should
bear some financial risk in respect of emergent technologies such as broadband. Thus, it is of
concern to see in the New Zealand Stocktake the indication that unbundling be used to shield
new entrants from financial risk-bearing – that is, the need for entrants to bear financial risk is
considered by the Stocktake authors to constitute a barrier to entry (para 82). It is not at all
clear why the incumbent should be required to bear all risk and the incumbent offered a ‘free
option’ in the stimulation of market entry. Indeed, such unequal allocation of financial risk
might induce over-much inefficient entry. By Stigler’s definition of barriers to entry, such
financial risk does not constitute a cost that the entrant has to bear that the incumbent does
not. Therefore, there does not appear to be a credible case for the need to bear financial risk
to be considered a reason why entrants should be granted more favourable risk-bearing terms
over the incumbent in respect of investment in highly uncertain new technologies.
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3.2.2.1 Uncertainty and Investment in New Zealand
As will be illustrated in the subsequent section, during the 1990s, when New Zealand was not
subject to any unbundling requirements, the country was an OECD leader in the deployment
of new technologies by both incumbents and new entrants (including broadband
technologies). In this period, substantial new investments were made in Ethernet LAN (1995,
CityLink), fibre-optic cable (Saturn) and satellite (iHug) by new entrants, and by the
incumbent in DSL – Telecom was 3rd in the OECD (after the United States and Canada) to
provide commercial DSL services (Howell, 2003). However, when it became clear that
unbundling would be investigated by the Telecommunications Commissioner as an option in
New Zealand, investment in fibre by the new owner (TelstraClear) ceased19. The leading
competing infrastructure owner subsequently became a leading advocate for unbundling (as
evidenced in the Commerce Commission unbundling enquiry in 2003)20. This action would
be consistent with a firm, which previously saw merit in investing in its own infrastructure
when unbundling was not an option seeking a lower-risk alternative when unbundling became
a regulatory possibility.
Evidence exists of similar decisions being made subsequently, following the Stocktake
announcement.
Pullar-Strecker (2006) reports that Local Authority Shared Services, a
partnership between 13 councils including Environment Waikato, received a $50,000 grant in
February to develop a bid for funding from the $24 million Broadband Challenge fund to
build a high-speed digital network linking all local councils in the Waikato. However,
following the decision that unbundling laws would proceed, they decided not to proceed with
their application for broadband challenge funding in the current round. Chief Executive Jim
McLeod is quoted as saying “if Telecom is going to unbundle and separate its services from
its infrastructure, why would we want competing infrastructure”. The broadband challenge
government funding is specifically designed to provide financial incentives to new entrants to
develop competing infrastructures.
Hence, there is evidence that even grant capital
(essentially free, with no risk to shareholders) will not be used to develop competing
infrastructures if an unbundled option is ‘on the table’.
Indeed, the local authority decision appears even more bizarre, given that it may take many
months to pass the necessary legislation, whereas an alternative network could be installed as
soon as grants were finalised (was anticipated late June).
The decision suggests that firms
19
Presumably in anticipation of an unbundling adjudication by the Telecommunications Commissioner, then TelstraClear CEO
Rosemary Howard stated on November 29, 2002; “We believe it’s more industry efficient for TelstraClear to buy from Telecom
rather than build duplicate networks to reach consumers who are widely spread throughout New Zealand.”
http://www.telstraclear.co.nz/companyinfo/media_release_detail.cfm?newsid=81&news_type=tclArchive
20
http://www.comcom.govt.nz//IndustryRegulation/Telecommunications/Investigations/LocalLoopUnbundling/ContentFiles/Doc
uments/s.64ReviewsTelstraClear27May2003.PDF
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will forego benefits from owning infrastructure in the short term in favour of the lower risks
of accessing services from the incumbent in the medium to long-term.
Most certainly, the
decision is in direct contrast to the Government’s intentions in establishing the fund in the
first place – articulated by Digital Strategy programme manager Peter Macaulay, who is cited
as saying “local loop unbundling and the structural separation of Telecom shouldn't be seen as
an alternative to investment in network infrastructure by councils and communities” (this
example underlines the fact that the ‘mixed strategy’ suggested in the Stocktake of
unbundling on the one hand to stimulate entry, plus increasing grants under the Broadband
Challenge to encourage entrants to develop competing infrastructures are not interpreted by
the market as complementary strategies – rather, they are seen by some as mutually
exclusive). Nonetheless, the local body decision is rational when considering that they are
looking at the opportunity cost of the capital involved. McLeod says “what we would far
rather do is put any extra investment from the local community into where the holes are”.
The Waikato reasoning is precisely that utilised by all potential entrants use when assessing
the decision to use unbundled services rather than invest themselves. Moreover, it underlines
the incongruity of an unbundling policy operating alongside competing networks and
government subsidies to build competing infrastructures. Either the element concerned is a
natural monopoly, in which case unbundling (via the ‘ladder’) up to the rung below the
natural monopoly element is indicated, or it is not a natural monopoly, and the appropriate
strategy is to stimulate competitive entry of alternative infrastructures. Where both are
available, it is unequivocally better for an entrant to use the unbundled products, even where
investment has already been made, simply because the prices are certain, and the risks are
less.
3.2.2.2 Investment in Telecommunications as an Alternative to Non-Telco Investment
Given both the theoretical and anecdotal underpinnings to the risk and investment argument,
it is difficult to rationalise the OECD’s observations that unbundling is associated with
increases in investment in infrastructure. Whilst no empirical evidence is offered to support
their claim (indeed, the United States data seem to support the opposite), it is possible that
increases in investment in telecommunications infrastructure may have followed unbundling
decisions as a consequence of other effects. Firstly, investment may increase following the
implementation of unbundling simply because regulatory certainty replaces the uncertainty
that leads to a suspension of all investment by all parties whilst a regulatory decision is made.
Once the decision is made, a catch-up phase ensues (Bittlingmayer and Hazlett, 2002).
Secondly, the presence of unbundling may actually distort the platform on which the
investment is made.
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The Waikato council example illustrates the effect of the choice of platform where investment
is made. Whereas the council may have originally planned to invest in fibre or wireless
services, its decision to await unbundling suggests that, if any council investment is made at
all, it will be on the copper network.
The counterfactual investment on competing
infrastructures is not made, but the observed effect would be an increase in investment on the
copper network, simply because the unbundling regulations distort the technology choice.
The TelstraClear investment decision also appears to not only support the suspension of
investment in competing platforms, but also a likely increase in the investments on copper to
replace the foregone investments on the fibre network, once the unbundling decision is made
operational.
Thus, it is not at all clear that the OECD’s observations are actually capturing the effects of
the entire investment across the entire broadband market, or simply a substitution effect
towards the copper network engendered by unbundling. Given that the available data for
whole-market broadband investment is very patchy, but that telecommunications investment
data, courtesy of intensive regulatory reporting requirements, is widely available, it is highly
likely that the OECD observations, which are reported in the various editions of the
Communications Outlook, relate only to investments in the telecommunications networks. If
this is the case, then the observations reported are simply confirming the superiority of the
unbundling option for entrants where it is available. The net effect is higher investment in
copper networks, at the expense of the greater degree of competition that would have ensued
under the counterfactual of investments being made in alternative platforms.
3.3
Long-Term Dynamic Efficiency Effects
Thus, the theoretical and empirical literature, and even the anecdotal evidence, tends to
support the theory that unbundling leads to lower overall investment in new markets, as well
as delaying the time at which the investments are made. Both of these effects will lead to less
welfare for consumers. In the first instance, consumers are denied the greater choice that
competing infrastructures offer. In the second, they are forced to forego welfare waiting for
investments to be made. Simply because the counterfactual cannot be easily measured, and
has been hampered from developing to the extent that it might have by the distorting effects
of the presence of unbundling, does not constitute proof that unbundling has ‘succeeded’.
Arguably, the extent of investments made in New Zealand prior to 2001, as will be discussed
in the next section, suggest that vibrant, inter-platform competition is more likely to occur,
and to occur earlier, when unbundling is not mandated than when it is.
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Variance 4. The New Zealand Investment ‘Problem’
When considering whether unbundling, or any other policy, will stimulate investment in
telecommunications, or ‘information exchange’ markets, it is apposite to consider firstly
whether an investment problem actually exists. Secondly, if it is deemed that a problem does
exist, all possible causes must be investigated. It is insufficient to conclude that, simply
because New Zealand’s investment levels are lower than those of other countries in a given
period that this constitutes ‘underinvestment’. Whilst differences in competition policy may
have some explanatory power, it does not necessarily follow that all of the differences
observed can be attributable to this ‘cause’, or even that it is valid to compare simple
investment statistics in coming to conclusions about either the relative or absolute differences
in investment levels without some further understanding about the scale of operations, the
nature of the market, and the history of technological investment in the markets being
compared.
The Stocktake authors rely substantially upon a second Network Strategies report,
‘Telecommunications industry investment in New Zealand’ in coming to their findings that
investment by Telecom has been ‘unsatisfactory’, and that regulatory intervention is required
to stimulate investment’. As with the report on broadband uptake, this report relies upon
incomplete analytic processes to provide the foundation for the Stocktake authors’
conclusions that Telecom’s investment has been ‘too low’ in the period pre 2003, and that
sector investment will be greater under unbundling. Consequently, the conclusions are drawn
once again upon incomplete, and potentially misleading, data.
In the first instance, the report summarises the current and future investments of a number of
participants, but examines the past investment only of Telecom. This occurs because the
OECD data used, in the 2005 Telecommunications Outlook, at least, which are based upon
the Teligen data set, do not include investments made by Vodafone21. Thus they are at best
inaccurate (and quite likely equally inaccurate in respect of the other countries with which
comparisons are made) but also likely an underestimate of actual investment. In the second
instance, selective presentation of investment data makes it difficult to ascertain the true state
of New Zealand’s investments over the period 1997-2003, and the authors provide only very
scant explanations as to why the observed data patterns exist. For example, the only reference
to potential distortions in the pre-2002 investments from inaccurate demand projections
fuelled by the investment requirements on incumbents under unbundling laws is that “the
exaggerated expectations during the hype of the ‘dot.com bubble’ caused overinvestment and
21
Personal communication with Teligen, via a customer of the Teligen database.
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poor management decisions, which left companies with high levels of debt. A number of new
entrants pulled out of the market, whilst others cut back on investment” (p 48). Whilst New
Zealand’s comparatively lower levels of investment over the period 1997-2002 are
highlighted, the suggestion is never made overtly that rather than New Zealand’s investment
levels being ‘too low’, the data might have been depicting evidence of the poor investment
judgements made in other countries resulting in investment levels being ‘too high’ in other
jurisdictions.
Furthermore, the authors make no attempt to analyse the state of investment by any party,
including Telecom, under the relevant regulatory counterfactual that applied prior to the
regulatory changes following the Telecommunications Inquiry, where it was signalled that
unbundling would be examined.
Under these arrangements, there was no prospect of
regulatory intervention of the form that has occurred subsequently. Thus, the conclusions are
made using data sourced in a period where there was substantial regulatory uncertainty, which
undoubtedly affected the level, form and timing of investments actually made by all market
participants (Bittlingmayer and Hazlett, 2002). Thirdly, future investment plans are sought
from selected market participants on the basis of self-reported plans and ‘industry views’,
with many of the investments proposed conditionally upon the presence of LLU. It is not
recorded what plans the ‘conditional’ investors might pursue might be under the scenario of
the status quo continuing, or the alternative scenario of regulatory uncertainty being removed
by the elimination of any further possibility of LLU being an option. Thus, the conditional
investment figures provided contain a reporting bias towards unbundling generating greater
investment, especially in respect of those entrants who have made no substantial investments
in their own infrastructure to date (e.g. Econet), making preparation of alternative scenarios
problematic.
Consequently, the impression left by both the Network Strategies and Stoctake reports is that
New Zealand exhibited a significant level of underinvestment pre 2002. Furthermore, the
increases in Telecom investment subsequently are attributed to regulatory intervention
(presumably the mandating of compulsory wholesaling and bitstreaming in 2004).
In order to address the question of whether there really has been an ‘investment problem’ in
New Zealand telecommunications markets, this section will examine the state of New
Zealand’s information exchange markets through the 1990s and 2000s in greater detail.
Whilst this analysis cannot cast any light on the future plans of new entrants, it will illustrate
investment patterns prevailing prior to the regulatory uncertainty that prevailed post 2002.
There is little evidence of an investment problem in this period. To the contrary, there is
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evidence that the ‘light-handed’ regulation applying at this time was instrumental in the
relatively early deployment of new technologies relative to other countries (that is,
unbundling regulation may have delayed broadband availability in some countries), and that it
cannot be discounted that regulatory uncertainty, rather than absence of competition or
exertion of market power on the part of Telecom, may have been responsible for delays in
development of the technology platforms in place in 2002.
4.1
Background: New Zealand Telecommunications Markets
Before a full discussion of New Zealand information exchange markets can be undertaken, it
is necessary to discuss a few relevant details about the underlying characteristics of the New
Zealand telecommunications markets.
As a long, thin country, with widely-dispersed
populations, low population densities and a very small market, New Zealand has typically
exhibited substantially higher costs to service each customer than many other OECD
countries. Alger and Leung (1999) find New Zealand, along with the United States, Sweden
and Australia, to be one of the most costly countries to service in the OECD as a consequence
of these factors. When benchmarking investment and prices, these factors must be taken into
consideration. One consequence of the higher costs per line is that New Zealand has typically
recorded fewer fixed telephone lines per capita than other OECD countries. These same
characteristics mean that it is comparatively more expensive to make new technologies
widely available in New Zealand than in most other OECD countries. Hence, Alger and
Leung suggest that higher prices charged for POTS and other telecommunications
technologies might be expected. Thus, New Zealand’s high percentage of GDP spent on
telecommunications relative to other OECD countries may reflect higher costs translating into
higher prices.
Furthermore, New Zealand has long maintained social policy of ‘averaging’ telephony access
prices across the country (‘universal pricing’ or ‘geographical averaging’ - see Appendix 2).
This policy was enshrined in the ‘Kiwi Share’ (later the TSO) when Telecom was privatised
in 1990. Also enshrined in this requirement is that Telecom must provide a residential tariff
that includes zero calling charges for local calls (unmetered calling), and the price was fixed
at no more than that prevailing at the time of privatisation (allowing for increases only in
proportion to the CPI). Together, the unmetered calling and geographically averaged prices
mean that the out-of-pocket prices charged to New Zealanders may be high, but usage is also
commensurately high. High usage relative to other countries is confirmed by NZIER (2005)
with respect to the rest of the OECD, and Howell and Obren (2003), with respect to the
United Kingdom.
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In the latter paper, the authors compare New Zealand call volumes with those reported in the
United Kingdom, and find that volumes for both voice and data are substantially larger per
line). Unmetered calling, in particular, has had a significant effect upon the volumes of data
placed through dial-up telephony networks. Nonetheless, prices for fixed line telephony
services declined at nearly twice the rate in real terms in New Zealand in the period 19912000 than prices in the rest of the OECD (Howell and Obren, 2003: 9), largely because prices
were static in nominal terms throughout this period (that is, although Telecom was able, under
the Kiwi Share, to increase prices in line with the CPI, it did not avail itself of this option –
prices remaining static in nominal terms declined steeply in real terms – it is noted, however,
that many countries did engage in substantial geographic and market segment ‘de-averaging’
of prices over this period – in part contributing to the lower price decreases recorded overall
in the rest of the OECD).
New Zealand prices for fixed line services were able to be kept stable, despite the large
increases in traffic, largely because New Zealand’s telephony infrastructure was fully
digitised at a very early stage relative to other OECD countries, meaning that capital outlay
requirements were comparatively less than in countries still digitising. By the time New
Zealand’s network was fully digitised in 1995, only the Netherlands, France, Iceland and
Luxembourg had fully digital networks (Finland and Norway were fully digitised at around
the same time; the UK was only 88% digitised, Australia 62%, Denmark 61%, Switzerland
66% at this point). By contrast, Australia did not complete digitising until 1999, and by 2003,
the United States was still not fully digitised.
Therefore, one of the important investment
activities in the latter half of the 1990s across the OECD was the completion of digital
networks in order to facilitate the widespread carriage of digitised information; yet New
Zealand’s investment in this technology was completed before this point in time. Thus, New
Zealand investments could be expected to be commensurately lower in the latter half of the
1990s than those countries still actively engaged in completing digital networks.
The early completion of the digital network highlights another feature of New Zealand
telephony markets.
As a small country with all technology installed approximately
contemporaneously, restricted budgets to spend, and the small population to which the
services are sold and from which investment costs must be recovered via service prices, New
Zealand has not widely installed every version of every frontier technology every time the
frontier changes.
Rather, the pattern has typically been to install a single technology
(typically the frontier technology at the time of investment) across the whole country over a
relatively short time period (digitisation occurred over an eight year time horizon), operate it
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for its complete economic life, and then replace it when fully expensed with the current
frontier technology. Given that the typical investment cycle has been 20 years, this has meant
that New Zealand has not widely deployed technologies that were the frontiers during the
middle of the investment cycle. For example, whilst ISDN superseded digital networks as the
frontier technology, and was widely installed in some countries (e.g. the United States and
Germany), it was not widely deployed in New Zealand, given that the investment in
digitalisation had only just been completed. Rather, it was installed only in small scale and
then predominantly in urban business markets.
Thus, the nature of the New Zealand market means that investment patterns tend to be
‘lumpy’, with the entire infrastructure tending to be replaced contemporaneously, simply
because the small size of the market allows this to occur. Furthermore, this investment
pattern means that the New Zealand industry will not necessarily ‘catch every technology
wave’ that passes – rather, the investment pattern has typically been to install a core
infrastructure, fully utilise it, and replace it, rather than maintaining multiple technologies
running (both frontier and vintage) in parallel at the same time. Given that Telecom had
already committed to building its Next Generation Network (NGN), and appears to be
planning a similar national rollout of the new technology platform over a short time horizon,
in the manner typical of past large-scale investments, it is questionable how much additional
investment the firm would have chosen to devote to upgrading facilities on a network that was
shortly to become redundant. The ability to augment investment in the old network may be
feasible in a country where the rollout of new frontier technologies occur as and when each
previous investment comes up for renewal, and investment cycles are dispersed over a large
number of different geographical regions.
However, in smaller countries, such
‘augmentation’ and multiple technology platforms operating concurrently may not be
economically feasible. Thus, the best comparator countries would appear to be those which
are small, digitised early, and have already committed to move to NGNs – Denmark, Ireland,
Norway and Sweden.
4.2
International Comparison of New Zealand Investment History
Whilst the Network Strategies document examines a number of investment elements and
compares New Zealand to a range of other countries (pp 41-66), the comparisons are partial,
and many of the differentiating factors have not been accorded the significance which is
warranted, given the discussion above. As with the broadband uptake drivers analysis, if
these factors were known, then not to have discussed them fully in the interpretation of the
data observed leads to an incomplete and unreliable analysis.
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4.2.1
Investment as a Percentage of GDP and Access Channels
As discussed extensively in variances one and two above, New Zealand’s relatively low GDP
per capita leads to lower numbers of access lines per capita. Moreover, New Zealand’s
geography and population distribution typically leads to higher costs per access line. Thus, it
is not surprising to find that New Zealand exhibits fewer access lines per capita than most
other countries in the OECD (25th). This raises the question about which is the appropriate
metric to compare New Zealand’s relative investment performance with that of other
countries. New Zealand’s low levels of GDP suggest that, with lower numbers of lines per
capita, New Zealand’ investment per capita will always fall short of the OECD average,
simply because investments are being made in respect of fewer access lines.
Figure 4.1
Investment per Capita 1997-2003
250.00
$US
200.00
150.00
100.00
50.00
0.00
1997
1998
1999
2000
2001
2002
2003
Year
OECD Average
NZ
Thus, it is not surprising to find that this is the case in practice. Network Strategies graph
(Exhibit 3.8) showing a large number of countries portrays a confusing picture. However,
Figure 4.1 shows that for the period 1997-2003, New Zealand fell consistently below the
OECD average in this metric. However, investment per access channel shows a different
pattern (Figure 4.2)
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Figure 4.2
Investment per Access Channel 1997-2003
250.00
$US
200.00
150.00
100.00
50.00
0.00
1997
1998
1999
2000
2001
2002
2003
Year
OECD Average
NZ
Whilst Figure 4.1 shows New Zealand had a relatively consistent pattern of investment per
capita across this period, Figure 4.2 shows a very slight decline, followed by relative stability,
which is consistent with the stabilising at a lower level following a period of heavy
investment in digitalisation. By contrast, the OECD investment per capita shows a very
strong surge in investment, followed by a rapid decline to around the New Zealand 2003
levels.
Investment per channel around 2003 stabilises around the New Zealand level.
Network Strategies data show that post 2003, as a consequence of investment in the NGN,
New Zealand’s investment levels rise above the OECD average, as would be expected with
cyclical ‘lumpy’ investment in the next frontier technology.
Thus, New Zealand’s relatively low ranking in both investment statistics recorded by the
OECD and Network Strategies is largely due to the investment strategies of other countries
being highly volatile in this period, rather than volatility in the New Zealand investment
patterns. The fact that the investment levels post the ‘dot.com’ crash in the rest of the OECD
fall to around the historic New Zealand levels, is highly suggestive of an explanation
associated with the widely-acknowledged over-investment that occurred in other countries as
a consequence of the overly-optimistic expectations of those markets. The consistency of this
explanation is reinforced by Network Strategies’ exhibit 3.14 (p 54) which shows that New
Zealand only fell below the OECD median investment per access channel in the period 19946 – the start of the ‘dot.com’ hype.
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4.2.3
Comparison with Small Early Digitisers/NGN Investors
Furthermore, when New Zealand’s investment patterns are compared to the group of small
early digitisers committed to moving to NGNs (Figure 4.3) it is clear that New Zealand’s
investment levels per access channel across the 1997-2003 period have exceeded all but
Iceland. Thus, it is difficult to support a conclusion that New Zealand’s levels of investment
have been abnormally low per access channel, when compared to countries with similar
investment patterns.
Figure 4.3
Investment per Access Channel: Early Digitisers
400.0
350.0
300.0
$US
250.0
200.0
150.0
100.0
50.0
0.0
1997
1998
1999
2000
2001
2002
2003
Year
NZ
Finland
Iceland
Norway
Luxembourg
In addition, Figure 4.3 illustrates the inappropriateness of the use of investment per capita as a
comparator without taking other factors into account. Network Strategies (p 51) states that
“Norway in particular has experienced consistently higher levels of investment than New
Zealand even though it has a similar population”. However, Figure 4.3 shows that the
investment per access channel has in fact been very similar – if anything, New Zealand has
invested slightly more per channel over the period represented in the graph above. The
Norwegian investments relate to a network with 177.4 access lines per 100 inhabitants,
compared to New Zealand’s 120.1.
Whilst the population is equivalent in size, the
Norwegian network is nearly half as big again as the New Zealand network. Thus, it would
be expected that Norway would exhibit higher investment per capita than New Zealand
(indeed up to half as much again). Hence, the Network Strategies conclusions of a relative
underinvestment by New Zealand relative to Norway are misleading, and inappropriate for
the decisions required to be made in respect of the unbundling exercise.
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4.2.4
Investment as a Percentage of Revenues
As shown in Figure 4.4, New Zealand’s investment as a percentage of revenue is not out of
line either with the other early digitisers committed to investing in NGNs. Whilst Norway
and Iceland are consistently higher, Finland and Luxembourg are consistently lower.
Figure 4.4
Investment as a Percentage of Revenues
35.0
Investment % of Revenue
30.0
25.0
20.0
15.0
10.0
5.0
0.0
1997
1998
1999
2000
2001
2002
2003
Year
New Zealand
OECD Average
Finland
Iceland
Norw ay
Luxembourg
The key characteristic of this graph is the relative consistency of New Zealand’s investment
levels as a percentage of revenues. The rise and fall of Norway’s curve suggests that it might
not have been immune to possible over-investment during the ‘dot.com’ boom. Moreover,
New Zealand’s lower level than Norway’s in this metric might also be attributable to higher
revenues per access channel, given that investment per access line is so similar. However, it
cannot be discounted that Figure 4.4 is a reflection more of the revenue aspects of the New
Zealand market than the investment ones.
Thus, it is difficult to draw many useful
conclusions from this statistic without further examination of the revenue data. .
4.2.5
Revenues
Whilst not strictly part of a discussion of investment, it is noted that the Stocktake authors
place some considerable weight upon New Zealand having relatively high prices high prices
for its telecommunications services, based principally upon standard baskets used by the
OECD for comparative purposes. As discussed above, and by NZIER (2005), standard
baskets may not reflect actual consumption, given the usage patterns induced by different
means of charging for services. Thus, it is instructive to examine where New Zealand is
placed compared to other countries in respect of revenues.
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OECD (2005: 81) figures show that New Zealand was 17th in the OECD in revenues per
capita in 2003, but less than 1% below the OECD average in this statistic. When measured
per access path (fixed plus mobile, but excluding broadband lines), revenues rose to 6th in the
OECD, behind the United States, Switzerland, the United Kingdom, Japan and Ireland.
However, this figure was only 1.6% higher than the OECD average. In fact, New Zealand is
one of a cluster of countries in a band plus or minus 15% of the OECD average that includes
Ireland, the Netherlands, Iceland, Austria, Finland, Denmark, Canada, Sweden, Germany,
Portugal and Belgium. However, as the New Zealand pricing structures are biased towards
residential consumers buying services with a very high fixed component but a very small
variable component (i.e. local calls cost nothing), then high revenues per access line is not
necessarily capturing a pricing ‘problem’ but may equally credibly be reflecting a usage
pattern of a smaller number of fixed lines utilised more extensively per line as a consequence
of residential consumer preferences for fixed tariffs.
Figure 4.5
New Zealand Telephony Network Traffic 1996-2003
Whilst much emphasis is also given in the Stocktake to the high prices charged for mobile
services, using the OECD baskets, it is not at all clear that there is evidence of over-high
revenues being charged at the level of the customer. Figure 4.5 shows the minutes of traffic
per access line in New Zealand from 1996 to 2003, broken down by fixed, mobile, local
voice, interconnect (long distance and international) and dial-up Internet. Figure 4.6 records
average minutes of traffic per connection (i.e. fixed line traffic per relevant fixed line, mobile
per mobile connection).
These graphs show that considerable substitution is occurring
between fixed and mobile voice traffic (largely fixed moving to mobile), but that voice traffic
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in total has been reasonably static in total and per connection since 2000. Howell and Obren
(2003) detected signs that mobile telephony diffusion is reaching maturity in New Zealand,
which are confirmed by these traffic graphs.
Figure 4.6
New Zealand Per Connection Telecommunications Utilisation 1996-2002
Given that the OECD (2005: 82) data show New Zealand is 21st in the OECD in revenue per
cellular connection (25% lower than the OECD average) despite high usage (notably, the NZ
rank is higher in this statistic than the United Kingdom at 23rd), and that voice minutes per
connection on the fixed network are more than twice that made on the mobile network, this
suggests that relative prices and pricing policies play a large role in determining on which
network calls will be made. Thus, it would be difficult to make a valid assessment about the
comparative prices across OECD countries without taking into account the different effects
that different relative prices and pricing policies have on how and where revenues are
recorded.
That the Stocktake authors make claims about pricing relativity without
considering these factors means that their comparisons are incomplete and therefore likely
misleading.
4.3
New Zealand Information Exchange Markets pre-2003
The preceding parts of this section discuss the broad context of the telecommunications
markets in New Zealand. However, the specific emphasis in the Stocktake is upon how
interactions have affected the markets for broadband. As broadband services are provided by
a variety of technologies, it is insufficient to look only at the telecommunications markets
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when examining sector behaviour. The FCC (2005) has determined that the relevant market
is the information transfer market. Patterns of investment and utilisation must take into
account the wider effects of the growing market for Internet use and how the pricing
structures in New Zealand have influenced investment.
Howell (2003) and Howell and Obren (2003) discuss how the early digitisation of the New
Zealand network, unmetered pricing, and geographic averaging of residential telephony tariffs
are all significant reasons why New Zealand was well-placed to support rapid and early
uptake of Internet applications based upon dial-up modems. Figures 4.5 and 4.6 show clearly
that, from nothing in 1996, Internet traffic grew to twice the volume of voice traffic by 2003 –
i.e. network traffic roughly trebled in this time. However, because of the ‘Kiwi Share’
obligations, Telecom was unable to charge for any of the additional Internet traffic generated
by residential consumers who continued to purchase unmetered charging services (presumed
to be in excess of 90% of residential customers)22. Telecom’s real price charged for the
services provided on fixed lines actually fell in this period, as the option to increase charges in
line with the CPI was utilised only once – that is, by 2003, nominal revenue per minute of
traffic had fallen to less than one third of what it had been in 1996, with the decline in real
terms being closer to one quarter of 1996 levels.
Thus, unlike telecommunications providers in most of the rest of the OECD, who could
recoup revenues per call or per minute on Internet data calls, Telecom was unable to charge
residential consumers for any part of their additional traffic. The result was a substantial
increase in consumer welfare from Internet usage, but with all associated costs of meeting the
additional traffic being met by Telecom from existing revenue streams – that is, a welfare
transfer from Telecom to consumers, along with the increase in consumer welfare from the
use of Internet-mediated applications. Without doubt, the ‘Kiwi Share’ tariff obligations
placed Telecom under a significant revenue constraint relative to those providers charging
metered prices (the rest of the OECD, except for Australia, Canada and the United States,
although it has been noted that many other countries have subsequently introduced unmetered
dial-up plans). That the New Zealand dial-up user numbers and usage per connection are so
substantially larger than virtually everywhere else in the OECD means that this burden upon
Telecom has been more significant that for virtually every other incumbent provider in the
OECD.
22
The ‘Homeline Economy’ tariff offering metered calling was withdrawn from the market in mid 2004. The only residential
connections now sold are umnetereed; the only metered plans remaining are those customers ‘grandfathered’ from the old
Holeline Economy tariff.
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4.3.1
Telecom an OECD Leader in ADSL Deployment
The revenue pressure from ‘free’ (zero marginal cost) dial-up Internet access has had the
effect of providing strong incentives for Telecom to search for, and implement rapidly, any
technology that would allow additional charges for Internet access to be levied on users.
Because of the size of the losses incurred from traffic growth, Telecom has faced very strong
incentives to migrate customers off dial-up infrastructures and onto other, chargeable,
technologies as soon as possible. Thus, the suggestion made in the Stocktake that Telecom
has been deliberately obstructive and tardy in investing in broadband capacity in order to
retain revenues from dial-up customers is inconsistent with the theoretical incentives and
observed usage patterns, and diametrically opposed to the firm’s actions as observed in the
market. Indeed, pursuit of maximum profits would have led to Telecom exercising its right to
increase residential tariffs in line with the CPI far more frequently than was observed over
this period.
Far from being a tardy investor in broadband, Telecom moved rapidly to implement ADSL
products.
When these products were first offered commercially in January 1999, New
Zealand became only the 3rd country in the OECD (after the United States and Canada –
Korea followed shortly afterward) to have commercial access to telephony-based broadband
products (Howell, 2003).
4.3.2
Product with ‘Leading Edge’ Speed
Moreover, the initial product offered in the New Zealand market, at a downstream speed of
2Mbps, was one of the fastest commercially-available products at the time. OECD (2001:53)
records only Korea as having a faster commercially-available product (8Mbps) in 2001. A
128kbps product (equivalent to the speeds available on ISDN lines in countries where this
technology was available) was offered 18 months after the initial release, to residential
customers only. This product was targeted at dial-up users, and had very generous data
allowances (5Gb), in order to induce switching from dial-up. The 256kbps product, which
was the typical entry point ADSL product offered in most other countries in the OECD, was
not added until 2003. It is most likely that this product was added in order to meet the
specifications in the Government’s Project Probe tenders, which called for this speed to be
provided.
4.3.3
At Internationally Low Prices
When introduced, the 2Mbps product was not only the second-fastest base level offering in
the OECD, but it was also, in two of its data cap variants, represented the third and fourthbest value products in measured as a weighted upstream and downstream average of kbps per
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dollar per month (OECD, 2001:53). Prices have continued to be low by OECD standards (see
above), when allowing for the speed of the product and the usage baskets represented by
actual New Zealand customers.
4.3.3.1 Data Caps and Local Access Networks
It is apposite at this point to consider the effect of data caps on the New Zealand broadband
market dynamics. Three OECD countries have historically charged for broadband plans using
data caps – Australia, New Zealand and Iceland. Notably, these three countries are island
nations, with relatively small populations, located at some considerable distance from the
source of the majority of the data consumed by their resident Internet users. Until 2004, when
a second cable, linking Australia to Asia was lit, all were at the end of a single fibre-optic
cable linking them to the rest of the Internet world.
Thus, it is incorrect for Network Strategies or the Stocktake authors to attribute the presence
of data caps to strategic pricing choices or market power in local access network ownership in
New Zealand. Rather, the data caps are a consequence of the fact that firstly, over 90% of
Internet traffic in New Zealand originates in the United States, and that secondly, virtually all
foreign-sourced data must pass over the single fibre-optic cable known as the ‘Southern Cross
Cable’ (jointly owned by Telecom New Zealand and SingTel). Whilst small amounts of data
can be transported by other mechanisms (e.g. satellite), for large volumes of data, the
Southern Cross Cable company has market power in the transmission of Internet data in and
out of New Zealand.
Even providers of stand-alone broadband infrastructures, such as
TelstraClear, Woosh, The Pacific Net and Compass Communications, are required to buy
capacity on this cable to meet their customers’ demands for the vast majority data traffic that
is sourced from non-New Zealand countries (predominantly the United States).
Consequently, all of these providers charge according to data consumption, as all are required
to pay the prices set by the provider with market power in this segment of the Internet
transportation value chain.
That many charge different rates for national traffic and
international traffic are reflections of the very different costs of transporting data in these two
different markets.
It is unknown whether the prices charged by Southern Cross to any extent reflect exertion of
the firm’s market power, as (to the author’s knowledge) no detailed examination has been
undertaken. It is quite possible that, given the small number of users, the extensive length of
this cable and the very large sunk costs that the investors must recover from a small user base
(Australia and New Zealand), higher charges per megabyte on this cable than on other
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transoceanic cables are legitimate. It is also possible that prices charged are excessive. Only
a detailed inquiry can establish these facts.
4.3.3.2 Local Access Competition Cannot Reduce Prices for International Traffic
Given that it is widely acknowledged that New Zealand broadband prices are at the low end
of the OECD for low volumes of data, it would appear that there is no compelling argument
supporting intervention in the markets for these services (the key features provided by local
loops at the ‘last mile’ of the broadband chain). However, local loop unbundling can only
influence factors pertaining to the local access market.
Thus, if it is only in respect of
transoceanic data transfer capacity that the New Zealand broadband prices differ from others
in the OECD, stimulating additional competitive entry in local access services will be futile
in reducing total broadband costs for high users as long as most data consumed is sourced
overseas.
By extension, the rationale for unbundling to stimulate lower prices and
competition in packages without data caps evaporates.
Nonetheless, the case for unbundling might still be pertinent if it increases transmission
speeds and capacities within New Zealand. Such capacity might be necessary if proprietary
content sourced once by a content provider (or a few content providers in competition with
each other) is to be distributed within New Zealand over local access networks. However, if
this is the underpinning rationale for unbundling, it begs the question of why the commercial
risks of building the transmission network for this proprietary content must be borne by
Telecom as a consequence of regulatory intervention rather than the content providers
themselves (i.e. why can the content providers not build their own access networks to
distribute this content, as Sky TV has?) Or alternatively, if the application has sufficient
merit, why can the provider not enter into a contractual agreement with Telecom to share
network facilities, thereby sharing the financial risks by mutual agreement rather than by
regulatory fiat? That these questions have not been asked or addressed is a key omission in
the Stocktake analysis.
4.3.4
Rapid Rollout, Wide Availability of DSL
Consistent with the strong incentives to deploy ADSL quickly, Telecom moved rapidly to
make the products available throughout the country. Furthermore, consistent with the policy
of charging universal prices for its services, Telecom charged the same prices nationally,
irrespective of the costs of installing equipment in different exchanges, or the number of
customers serviced by each DSLAM.
By April 2000, the product was available in
Wellington, Auckland, Canterbury, Otago, Waikato, Bay of Plenty, Taranaki, Hawkes Bay,
Nelson, Southland and Manawatu-Wanganui. Between January 2001 and January 2002, the
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remaining regions Northland, Gisborne, Southland, Marlborough, West Coast and Tasman
were added (Howell and Obren, 2003). By early 2003, 85% of Telecom customers could
access DSL services (Howell, 2003). By 2005, 93% of customers could access the service.
Only Belgium, Denmark, Finland, Luxembourg, and the United Kingdom had higher
availability levels of DSL in 2005 (OECD, 2005). By comparison, the availability in the
other high-cost countries was substantially less – Sweden 90%, Australia 84%, the United
States 84%.
4.3.5
Inconsistent with the ‘Monopoly Power’ Investment Thesis
Telecom’s very early, very rapid, low-priced deployment of its DSL infrastructure, and the
provision of the very highest quality product, in terms of speed and capacity, is completely
inconsistent with its depiction in the in the Network Strategies and Stocktake documents as an
imvestment laggard trailing years behind its competitors in the implementation of products,
and then only providing low-quality, slow technologies. In 2003, Howell and Obren (2003)
assessed New Zealand to be some eighteen months ahead of Australia in its ADSL
deployment (Telstra first made the product commercially available in Australia in August
2000, with a standard residential offering of 256kbps, but with 512kbps and 1.5Mbps
products targeted at the commercial market).
Network Strategies and the Stocktake authors appear to have presumed that, as a party with
market power, Telecom has automatically chosen to utilise this power to resist change in its
market. However, the facts do not bear this out. Rather, the relevant question is not ‘why is
New Zealand so far behind its competitors in 2006’ but ‘why did the world-leading
investment strategy appear to stall from the beginning of 2002’? By not examining in detail
the nature of the markets prior to 2002, the authors have avoided having to ask this question.
4.3.6
Other Broadband Investments Pre 2002
The picture of the New Zealand information exchange markets is not complete without also
examining the investments made by other broadband suppliers up to this time.
4.3.6.1 Telecom the 3rd Broadband Technology to Market
Whilst Telecom has demonstrated very early and high-quality ADSL provision from January
1999, it was only the third provider of commercial broadband products in the New Zealand
market.
The absence of legislative barriers to entrance by new participants with their own
infrastructures that prevailed post 1990 was influential in stimulating investments in
competing platforms.
Whilst competitive entry saw Clear Communications (later
TesltraClear) entering in the fixed line business, and BellSouth (later Vodafone) becoming a
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full service provider in the mobile market, competition was also present in the broadband
markets. Ethernet LAN provider CityLink was the first to provide broadband services (in the
central Wellington business district) in 1995-6. CityLink has a large client base in the
government, education, banking, finance and medical markets – all distinguished by their
high use and early adoption of high volumes of information exchange – Howell (2003);
Foreman and Goldfarb (2005).
The second entrant in the broadband market was iHug’s satellite internet services in 1998
(Howell, 2003). In the benchmarking done between 2000 and 2003, the iHug satellite service
was the price leader in the New Zealand market (satellite services are now provided by
ICONZ). It is also noted that the satellite service was available nationally, and was especially
desirable for rural consumers unable to access DSL services due to their distance from the
exchanges and remote DSLAMs.
4.3.6.3 Cable Entry in 1999
Cable modem services were first offered by Saturn Communications (subsequently
TelstraClear) in Wellington in 1999, shortly after the commercial release of ADSL. The
rollout was subsequently extended to Christchurch in 2001, but further development was
suspended in 2002. TelstraClear and Telecom have maintained very similar pricing for
products of similar quality from the inception of both services.
Notably, Telecom and
TelstraClear have come to a mutual agreement that TelstraClear will not onsell Telecom’s
wholesale and bitstream products in the areas where TelstraClear has a network presence,
thereby preserving the incentives for TelstraClear to maintain and improve the quality of the
network infrastructures that are already installed.
4.3.6.4 Fixed Wireless Entry in 2001
Walker Wireless (subsequently Woosh) first entered the broadband market in the Auckland
CBD in 2001. The network has subsequently expanded to include a 50km radius from the
centre of Auckland, Wellington, Christchurch and Invercargill, with plans to enter in other
provincial centres23.
Woosh benefited from some of the Project Probe contracts to install
infrastructure in rural locations.
Subsequently, many other local providers have entered the market with local wireless
networks focusing upon rural, urban and suburban markets. Notable in this are:
23
http://www.woosh.com/ContentClient/WhyWoosh/WhyWooshOffer.aspx
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•
Wired Country (subsequently Compass Communications), with a mixture of
wireless and fibre networks that cover an extensive area in Warkworth,
Auckland’s North Shore (Albany, Dairy Flat, Orewa), Auckland City (from
Takapuna to Manukau, Waitakere City to Howick), Howick, South Auckland
(Franklin, Papakura), and Hamilton City – thus covering the entire area of
New Zealand’s most populous city24;
•
The Pacific.net in the top part of the South Island, covering Golden Bay,
Tasman, Nelson, the Wairau Valley, Cloudy Bay, Picton, the Marlborough
Sounds, Awatere and Buller25.
The entry of wireless providers has been facilitated by the wholesaling of trunk and backhaul
facilities by state-owned BCL26, the seed funding provided by Project Probe, and commercial
agreements between the various infrastructure providers, including Telecom. For example,
Fonterra has negotiated an agreement with multiple providers to enable a multi-platform set
of products and services to be made available to its 13,000 members (Corbett, Howell, Mishra
and Ryan, 2004) that includes services from Telecom, BCL and local wireless providers.
4.3.6.5 Mobile Broadband
Mobile broadband has been available on Telecom’s CDMA network since 2002, and has
subsequently been matched by a comparable service from Vodafone. Both Telecom and
Vodafone indicate that their mobile broadband services are available widely across the
country (estimates are as high as 95% of the locations New Zealanders live, work and enjoy
recreation in). Whilst prices for mobile broadband have historically been higher than those
for landline and wireless services, recent price reductions for a 1Gb monthly plan27 see it
priced at only a small margin (20%) above a similar data quantity on a fixed line.
4.3.6.6 Wireless Hotspots
Wireless hotspots have been available in New Zealand from late 2002, initially provided by
CityLink and subsequently by other providers.
CityLink’s CafeNET provides over 200
access points in Wellington and is proposing to provide hotspots in Auckland in the near
future, in conjunction with its planned Ethernet LAN expansion into this market. Telecom
provided over 300 hotspots nationwide at July 17, 200628.
24
http://www.wiredcountry.co.nz/coverage.html
http://www.thepacific.net/index.php?id=37
26
http://www.scoop.co.nz/stories/BU0603/S00498.htm
27
http://www.vodafone.co.nz/promos/1gbfor49/1gbfor49.jsp
28
http://www.telecom.co.nz/binarys/hotspots20060717.pdf
25
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4.3.6.7 Other Fibre providers
In addition to the retail suppliers, a number of other providers have invested in fibre-optic
cable, either for their own use, or for wholesaling purposes. Utilities companies have been
especially active in this area. For example, United Networks began laying fibre alongside its
electricity cables in metropolitan areas as early as 2000, and Vector has continued with these
activities, as cited by Network Strategies.
4.4
Competition in the New Zealand Broadband Market Post 2003
The earlier entry of high quality, low-price, widely available competitive infrastructures has
undoubtedly had an influence upon Telecom’s strategic approach to the broadband market.
The presence of high-quality, fast, fibre-based services provided by competitors was
instrumental in Telecom choosing Wellington, rather than the more populous Auckland, for
the launch of its ADSL services, as the market for the product had already been proven in this
location by CityLink, and Saturn was committed to investing in this market. The quality of
the CityLink product may also have had a role to play in the quality of product (i.e. highspeed) used as the entry level product. That the price-leading satellite product was available
nationally undoubtedly placed significant price disciplines on Telecom, and may have been
instrumental in the decision to charge universal prices for ADSL, despite the different costs in
different locations.
Moreover, the mere presence of competitors, and the awareness that Telecom had that
politicians might subsequently move to apply tighter regulations if there was any evidence of
exertion of market power meant that, once other providers were in the market, there would be
an expectation that Telecom would also be providing services. As the incumbent supplier of
national services, there was widespread recognition that Telecom would need to be seen to be
responding proactively to competitive entry. As the new providers offered benchmarks in
price and quality of broadband services, the competitive influence that they exerted on
Telecom, given the threat of regulation, was substantially greater than their small market
shares might suggest.
4.4.1
No Evidence of An Infrastructure Supply Problem
Consequently, the observed investment patterns pre 2003 provide no suggestion of either a
shortage of competitive entry into the broadband market in New Zealand, or anti-competitive
behaviour between infrastructure providers, including Telecom.
The collaborative
agreements that Telecom has reached with a number of providers, especially for the provision
of broadband services to rural areas where ADSL will not be a feasible solution given current
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technologies, are not consistent with this scenario.
As Howell (2003) noted, New Zealand
exhibited in 2003 high quality, low-priced, widely-available broadband on a variety of
competing platforms, offering substantial consumer choice and a range of infrastructures that
appeared unparalleled in the OECD. Indeed, it is feasible, given the distortions in price
signals arising from the extensive geographic averaging of broadband prices, there may have
been some inefficient over-investment (and possibly over-entry) in duplicate networks in
urban areas, and a relative under-investment (and possible under-entry) in rural investment
(see Appendix 2).
Given the evidence of vigorous inter-platform competition where feasible, and inter-platform
collaboration where desirable, it is apposite to revisit the question of why, relatively, New
Zealand appears to have slipped from this world-leading position post-2003. If the regulatory
regime and competition laws governing the market prior to 2003 were complicit in generating
this environment, then it is possible that a change in the competitive or regulatory
environment may have contributed to the relative decline.
The significant change that
occurred in the competitive environment was the 2000 Ministerial Inquiry into
Telecommunications, and the obligation that the recommendations from this inquiry imposed
upon the Telecommunications Commissioner to undertake an inquiry into the viability of
unbundling in the New Zealand market by the end of 2003 (as required by Section 64 of
Telecommunications Act that arose from the Ministerial Inquiry).
Whereas prior to the
Inquiry, there was no possibility of unbundling being available as an option for entrants, the
Section 64 Inquiry provided a real possibility that lower cost, lower risk entry options would
be available.
4.4.2
But Regulatory Uncertainty Implicated in a Change in Competitive Interaction
Thus, it cannot be discounted that the very act of making unbundling a regulatory possibility
was responsible for the dampening of vigorous inter-platform competition. As has already
been noted, the second largest infrastructure investor TelstraClear suspended investment in its
networks in 2002, clearly citing the potential of utilising Telecom’s infrastructure as a reason.
Regulatory uncertainty would also have affected Telecom’s investment incentives. Appendix
1 shows that the rational response of an incumbent faced with possible requirements to share
new infrastructures is to withhold investment as long as possible. The spectre of unbundling
would thus have had implications not just for any further investments on the existing network
(e.g. upgrading DSLAMs to higher speed ones) but also on the commitment to proceed with
investment in the NGN. Given the level of uncertainty that prevailed about exactly what
services and investments would be subject to unbundling, the logical strategy of all
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participants in the market would have been to suspend investment awaiting some certainty
about the future regulatory environment (Dixit and Pindyck, 1995).
The Section 64 Inquiry, however, did not come to a clear, binding decision about the future
state of regulation in the sector.
Rather, its series of compromises, including limited
bitstreaming and unclear market share targets for broadband uptake, agreements about levels
and timing of investment by Telecom in the NGN, and ongoing threats to revisit the
unbundling decision if agreements and targets were not met, served to keep alive all of the
uncertainties that prevailed in 2003.
Consequently, substantial regulatory uncertainty prevailed from at least the end of 2002 until
the May 2006 Stocktake announcement that unbundling would proceed. It would appear that
it was in this three-year period that New Zealand slipped from being a world leader in the
deployment of copper telephony-based broadband infrastructure to being, as the Stocktake
authors suggest “approximately three years behind the broadband performance required to
meet the Digital Strategy target” (para 24). Thus it is not improbable that the ‘cause’ of the
delay is a ‘competition problem’ induced by regulatory uncertainty. The discussion in this
section would suggest that it would be inadvisable for decision-makers to make a hasty
decision based upon information solely pertaining to the post-2002 environment, without
fully exploring the alternative explanations for observed outcomes and behaviour.
4.4.2
Competition in Infrastructure or Customer Markets?
It is appropriate at this point to also revisit the questions raised in section 3.1.1 and 4.3.3.2
about exactly which market that competition is occurring and will be facilitated by
unbundling – the infrastructure market or the market for customer relationships. When a
provider already has made an infrastructure investment, but this investment is in one locality,
or covers only one type of service, the provider can only offer a service with a single billing
point for customer locations in different areas where services unable to be physically provided
over the owner’s proprietary infrastructure are obtained from other providers, or the provider
replicates the infrastructure. Thus, an infrastructure investor may favour unbundling to get
access to these inputs at regulated, rather than negotiated, terms.
It would be dangerous, therefore to presume that all entrants will enter an unbundled market
with the intention of building their own infrastructure. Indeed, the motives underpinning the
business strategies of some users of unbundled services will never lead to network
duplication, not because it is not economically feasible, but because the intention is to ‘win’
the customer relationship by any means. If the customer can be ‘won’ without having to
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make further infrastructure investments, then the company has succeeded on the back of an
investment made by a potential competitor for the customer, yielding a double benefit.
In
such ‘winner take all’ competitions for customers, it must be questioned why only one firm
should be required to bear the costs of sharing its infrastructure – that is, be hampered in the
competition for retail customers in a new ‘triple play’ market which is starting afresh with no
defined customer bases, when it offers historically only one or two of the underlying
components in the triple play bundle.
Thus, it might be concluded that the real market for competition underlying unbundling is the
market not necessarily for the copper lines that link customers to telecommunications
companies, but for the customer at the end of the copper line. Competition in this additional
dimension adds a further explanation why existing network owners might favour unbundling
if they are retail providers, but be indifferent if they are wholesale providers. Caution must
therefore be applied when analysing markets that an ‘infrastructure bottleneck’ argument is
not inappropriately confused with a natural monopoly in the presence of multiple competing
infrastructures capable of providing services to a single customer, in order to enable
competitor access to the underlying source of the incumbent’s market power in an embryonic
market – its existing relationships with customers, which have been built up over decades of
being the sole provider of telephony services. If infrastructure duplication is feasible, then it is
not at all clear that there is any good reason why the incumbent’s ownership of the existing
customer relationship should or could be subject to regulatory intervention advantaging
entrants. Even if there is, it should be subject to the same analysis that would pertain to the
entry of any new player in a market where there is a dominant incumbent
4.4.3
The Incumbent Must Be Allowed to Compete for Customers as Well
To this end, it is of concern that the Stocktake proposals include not simply requiring
Telecom to open up its infrastructure to competitors, but also to provide further impediments
to Telecom responding to competitive entry in the manner which typically occurs when faced
by entry. Paragraph 81 of the Stocktake proposes that regulatory restraint be placed upon
Telecom preventing it from lowering its prices when an entrant using Telecom’s
infrastructure prices lower than Telecom. The only purpose that this would serve would be to
prevent Telecom from competing on a level playing field to retain its customers on the basis
of product quality and other factors. That it is included at all is highly suggestive of an
intention to create an uneven playing field that actually disadvantages Telecom in the market
for customer relationships. This is proposed even thought there is no detailed analysis
provided why Telecom should face such a disadvantage. That it is not discussed suggests
that, at best, neither the Stocktake authors nor their advisers have clearly separated out the
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many different assets that Telecom owns. At worst, the proposed regulatory remedies may
actually push the balance of market power so far in the opposite direction that Telecom’s
ability to invest is severely compromised. .
4.5
Analytical Weaknesses in the Stocktake Approach
This section serves to illustrate that the analysis undertaken for the Stocktake has been
cursory, and has failed to address the full extent of either competitive interaction or levels of
investment in the sector. The solitary focus upon investments in infrastructure in a narrow
time period has been at the expense of analysing a much wider variety of factors that have
contributed to the observed outcomes.
Once again, it appears that the analysis undertaken was substantially below the standard that
would normally be expected for such an important set of decisions.
Incomplete data,
selective presentation and a narrow, incomplete scope appear to have provided a stronger case
to support a finding of a competition ‘problem’ and regulatory intervention than appears
justified when these other factors are taken into account.
In particular, the absence of
examination of the potential underlying motives and strategies of entrants, whilst presuming
that Telecom is exerting market power, which is used to support the competition findings,
unravels when compared against the longer time horizon. Likewise, the inadequacies of an
approach which do not subject market entrants’ motives to the same examination runs the risk
not just of misdiagnosing the ‘problem’, but of implementing remedies that are unduly harsh
and potentially even more distorting than the perceived problems.
Whilst it is not suggested that the foregoing discussion is complete, it at least suggests that
there is at least one other interpretation that can be put on the observed data. That no other
explanations appear to have been sought or discussed highlights a significant methodological
failing in the analysis on these points.
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Variance 5. NZ Application of the Unbundling Proposals
Notwithstanding any of the findings of the previous sections, even if it is found that
unbundling is desirable, it is far from clear that the ways in which the Bill proposes to apply
the tool will achieve the desired outcomes.
Far from using New Zealand’s later
implementation as an opportunity to benefit from the experiences of other countries, the way
in which the Bill implements unbundling appears to ignore some of the key learning that has
ensued.
In the first instance, despite claiming that the proposals contained in the Bill represent
“regulatory international best practice as adopted by almost all jurisdictions comparable to
New Zealand” (p 35), both the process undertaken in the Stocktake and the ensuing Bill
contain deviations from regulatory best practice as advocated by ITU. Secondly, the ways in
which the unbundling analysis and implementation have been undertaken, whilst purportedly
informed by Cave’s (2006) ladder of investment as informed by applications in the EU,
United States and Canada, fall far short of an application consistent with the author’s
suggestions about the use of the ladder to stimulate investment. Thirdly, the regulatory
changes prioritise unbundling of the local loop ahead of addressing other regulatory
instruments such as geographic pricing and the TSO, which have been demonstrated to have
had significant distortionary effects upon all of investment, pricing and diffusion of Internet
technologies. To encourage entry and investment under the conditions prevailing under these
regulations, and then subsequently address the distortions that they induce appears both
illogical and irresponsible.
5.1
Regulatory International Best Practice
5.1.1
Inter-Platform Competition is Regulatory First-Best
The Stocktake authors ascribe strong emphasis to their claim that the OECD has identified
LLU as regulatory best practice. However, the claim is false and misleading. Since at least
2001, the OECD has been advocating that “the most fundamental policy available to OECD
governments to boost broadband access is infrastructure competition” (OECD, 2001:4).
LLU is supported by the OECD as a ‘second-best’ strategy, only where there is evidence that
vibrant inter-platform competition is not present, and then only as a stopgap measure to be
used only until such time as vibrant inter-platform competition is developed. The efficacy of
the inter-platform competition approach is evidenced in the discussion in Variance 2.
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5.1.2
LLU a Second-best in the Absence of Vibrant Inter-Platform Competition
To the extent that LLU offers a regulatory alternative, the OECD proposes it as a second-best
to be implemented only when there is no evidence of, or no other possibility of achieving,
vibrant inter-platform competition.
Given that New Zealand was exhibiting many
characteristics of vibrant inter-platform competition pre 2003 (noting that the nature of the
strategic interaction of parties often provides a better litmus test of the effect of competition
than market shares of entrants), it is far from clear that there is a compelling case for
intervention on this basis.
The evidence given in Variance 2 indicates that, despite great hopes being held for LLU, and
despite the strong advocacy that it has received from individuals within the OECD and the
EU, it is far from clear that it has been successful even as a second-best. Moreover, it has
been of negligible effect in stimulating rollout of infrastructures or uptake of broadband in a
number of countries. For example, it has had no effect at all in the deployment and uptake of
infrastructures in Switzerland and Korea, and has likely had negligible measurable effect in
countries such as Canada and the Netherlands, where strong cable markets are present.
5.1.3
Regulatory ‘Fashion’ or Empirically Robust Policy?
Rather, its status as the regulatory ‘fashion’ across the OECD has likely been increased more
by requirements for regional regulatory harmony in recently privatised voice telephony
markets (e.g. the EU) than by reasoned analysis of its effects in the broadband markets.
Indeed, most OECD LLU regulations were passed prior to the widespread deployment of
ADSL (OECD, 2003:16-17 shows only 7 countries mandated LLU after December 2000 – of
these, six were potential or actual EU members – Czech Republic, Greece, France, Hungary,
Iceland and the Slovak Republic). Whilst it is likely that Iceland’s unbundling was tied to
potential EU membership, it is unclear why either it or Korea, the other late unbundler, would
have adopted the policy, given that both had extensive competing networks and high
broadband uptake at the time of LLU mandating. In counties where detailed published
theoretical and empirical analyses of the efficacy of the policy have been undertaken more
recently (New Zealand in 2003 and the United States in 2004), the respective regulators have
recommended against extensive unbundling obligations in broadband markets (Commerce
Commission, 2003; FCC, 2005).
That the policy is still so strongly advocated by individual OECD officials, despite the clear
articulation expressed in official publications of inter-platform competition as the ideal, is
puzzling, given both the extent of the mixed findings of its efficacy, and the apparent lack of
evidence in many OECD countries of there being genuine, widespread natural monopolies in
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broadband access (although it is noted that there may be some local justifications for the
policy in some localities). It cannot be discounted that political economy reasons may be
more powerful explanators of the strength of OECD officials’ advocacy. It is noted that the
OECD has not published any rigorous empirical or statistical analyses to either support or
refute the use of unbundling; thus individual advocacy appears to be based mostly upon
intuitive reasoning using the ‘ladder of investment’ models promulgated by the EU. That
individual OECD officials’ advocacy is possibly an ‘article of faith’ rather than the outcome
of reasoned analysis is suggested by the MFAT cable authors, who comment that the OECD
officials’ “somewhat cavalier” attitude to quite plausible issues relating to the price of
unbundled elements (MFAT, 2006:7).
Simply because OECD officials advocate a policy that has been widely pursued either by
directive or fashion in its member jurisdictions does not make it ‘best practice’. Rather, such
advocacy may just record that the policy is popular. Thus, it cannot be discounted that the
strength of advocacy provided by OECD officials is influenced as much by ‘bandwagon’
effects driven by the popularity of the policy as it is by empirical argument. Instead, further
empirical analysis is indicated before any such claims can be accepted as valid. Moreover,
such analysis must take into account the circumstances specific to New Zealand, in order to
avoid falling victim to the ‘fashion sense’ of other jurisdictions, which may not suit local
circumstances.
5.1.4
Policy Variety and Sustainable National Competitive Advantage
It is noted at this point that Porter (1990) suggests that, from a strategic perspective, it is not
necessary in a country’s quest for a sustainable competitive advantage to simply copy the
‘best practice’ of other countries. Copying will just ensure that all countries are exposed to
the same benefits and disbenefits, and will respond similarly to uncertainties and economic
shocks. Moreover, learning and innovation is reduced, as there are no ‘live counterfactuals’
against which to estimate the efficacy of the policy, or alternatives that can be utilised of the
policy is less successful than anticipated. Telecom (and by extension, New Zealand) has
already been the beneficiary of a different regulatory approach when the 2001-2 ‘dot.com
bust’ occurred (ref).
It is highly unlikely that New Zealand will be able to outperform its
OECD rivals simply by copying them. Indeed, the outcome of such an approach may be
simply to cement in place a reasonably consistent New Zealand performance at the top of the
lower OECD quartile, with few opportunities for strategic or policy differentiation.
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5.1.5
Politically Independent Regulatory ‘Best Practice’ as Advocated by the ITU
In contrast to the OECD, the ITU does not directly advocate any particular set of regulatory
policies. Recognition is given to the efficacy of competition per se, with support from
regulation where clear evidence exists of competition being impaired. Moreover, the ITU
places much emphasis on the ways in which the regulatory process is conducted. Kelly
(2006) emphasises the importance of regulators and regulatory processes being independent
of politicians and political processes in order to ensure that national economies, rather than
vested interests, benefit not just from telecommunications infrastructures, but from all of the
aspects of the implementation and use of ICTs.
5.1.6
Clauses 9 and 31 Reduce Independence of the Commission
To this end, it is noted that the method by which the Stocktake was undertaken, and the extent
to which its agenda and outcomes have been subject to politicisation, is diametrically opposed
to the ITU’s recommendations that such processes are best undertaken by independent
regulatory authorities, removed from the political process, in order to avoid the possibility of
political bias or other vested interests influencing the outcome. It is also of concern that the
Bill explicitly introduces greater powers than previously available for the Minister of
Communications to recommend regulations (clause 31), and requires the Commission to have
regard to the economic policies of Government (in essence, the outcome of political
objectives) that are transmitted to it by the Minister (clause 9), when this is not an obligation
under the current Act. Both of these clauses would appear to be reducing the power of the
Telecommunications Commission to act independent of political direction, and therefore are
contrary to the ITU recommendations.
5.2
“Best Practice’ ‘Ladder of Investment’ Application
The ‘Stocktake’ authors place some considerable store upon the benefits of LLU stimulating
investment in infrastructure if they are applied in a manner that utilises the ‘ladder of
investment’ model advocated by the EU (ERG, 2005) and Cave (2006). However, despite
citing Cave’s paper as a reference, it appears as though neither the Stocktake process, nor the
Bill, have sought to either empirically investigate the case facts in the New Zealand markets,
or implement the ladder as Cave indicates it should be in order to stimulate investment.
Given that the authors appear to believe that under-investment is a ‘problem’ in New Zealand,
and that unbundling is necessary to ‘solve’ the problem, it is surprising that the Bill does not
seek to impose the regulatory instrument in the manner Cave proposes. Rather, as proposed,
the Bill appear to have more in common with the ‘negative’ application of the ladder as cited
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by Cave with respect to the United States than the positive effects that might be efficacious in
practice.
5.2.1
First, Establish the Natural Monopoly Elements
Cave begins with the presumption that “competition is the best regulator”, and that
unbundling promotes competition only inasmuch as it provides “transitory assistance to
overcome the advantages of the historical monopolist” in the pursuit of “competition on level
terms among operators” in the long run (p 223). Thus, it should be predicated upon “a desire
to stimulate entrants to build their own infrastructure” (p 224). Its successful application,
therefore, requires that “a detailed analysis of the particular circumstances is necessary if the
ladder of investment approach is to be applied rigorously and effectively” (p 226). The first
step in this process is to identify those elements of the incumbent’s infrastructure where it is
feasible to expect replication of infrastructure to be the long-term objective. Cave notes that
for copper-based telecommunications providers, this could be any of the copper loop,
DSLAMs, backhaul, core IP network infrastructure, access to the web and retailing or
reselling (p 231).
The necessary analysis requires both detailed cost-based modelling and evidence of
replication in similar circumstances to determine not only the absolute levels of replicability
that are feasible in a given market, but also the relative levels (229-30). Cave stresses the
importance of getting this step right, as “mistakes about the feasibility and desirability of
competition will have lasting consequences when implementing the ladder approach” (p 232).
He notes that “if it is decided that the local loop is a natural monopoly, then any regulatory
approach that creates infrastructure-building incentives in this element is not appropriate”
(ibid). However, the warning could equally be that providing unbundling opportunities in
elements that are already replicated may distort investment away from the competitive
infrastructure back to the unbundled one.
5.2.1.1 But No Principled Analysis Undertaken in the Stocktake
Thus, it is of considerable concern that the Stocktake documents undertake no empirical or
cost-based modelling to ascertain the feasibility of replicability or non-replicability in any of
Cave’s identified elements at any point or location within the Telecom network, or within the
networks of those providers who have already built competing infrastructures.
Rather, it is
simply assumed that as the copper loops are owned by Telecom, and Telecom has market
power, they must be unbundled.
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That all of bitstream, backhaul, local loop and sub-loop (co-location) are designated suggests
that the policy-makers have presumed, without any detailed analysis, all are replicable, but
copper loops are not. That such a finding can be presumed, despite the evidence contained in
the Network Strategies documentation of extensive full facilities competitor entry in many
metropolitan, provincial and rural areas, is astounding, and highlights the inadequacy of the
Stocktake analysis relative to the ‘best practice’ ‘ladder of investment’ implementation
theory. At the very least, the presence of any facilities-based competition in any area suggests
that competitors not only consider replicability to be economically feasible under current
market conditions, but have actually committed investments to replication of the copper loop
and full facilities-based competition with the incumbent. That entry has occurred indicates
that the implementation of unbundling will be highly complex. The inadequacy of the
underpinning investigation suggests that it is almost certain that Cave’s prediction of mistakes
occurring in determining the feasibility and desirability of competition that will have lasting
consequences will undoubtedly come to pass.
The inadequacy of process is highlighted by the failure to undertake regionally-sensitive
analyses, given that there is clear empirical and theoretical evidence that costs will vary in
different localities. For example, full infrastructure may be replicable in one exchange area,
but not even DSLAMs may be economically replicated in others. As indicated by the
application of the ladder in Canada, successful infrastructure investment requires these
elements to be examined in a principled, regional-specific manner if the appropriate
incentives are to be provided. That the Bill proposes a single, national, set of conditions
without taking these factors into consideration is fraught with potential costly and long-term
consequences.
A rational analysis would conclude that, if entry has already occurred, this is because the full
network can be replicated economically. In that case, unbundling would not be required
where full facilities competition exists. At the very least, the provision of cable infrastructure
in Wellington and Christchurch, and extensive competitive entry of wireless and Ethernet
LAN in metropolitan and provincial areas would suggest that full service competition is
present in a great number of areas of the country. Even if very high-speed access was deemed
to be required, then there would appear to be a need for restrictions in availability of
unbundled loops where these facilities are available – that is, Wellington, Christchurch and
the CBD areas of Auckland and other provincial towns where utilities firms have laid cable
and where TelstraClear has its own infrastructures. Moreover, the high degrees of variability
in population density across the country would appear to suggest that different elements may
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be replicable in different localities. At the very least, the cost structures will be different in
these different areas.
5.2.1.2 Motivated by Infrastructure Unbundling or Customer Unbundling Objectives?
Given the extensive and universal nature of the obligations in the Bill, it cannot be discounted
that the implementation presumes the existence of a further monopoly element bundled in
with the local loop that can never be replicated, and therefore can be accessed by new entrants
only by compulsory sharing – that is, Telecom’s existing customer base. In a ‘converged’
market predicated upon firms competing to manage all information exchange access for a
customer, in the presence of extensive competing infrastructure the customer is the only nonreplicable element. If the extensive nature of New Zealand’s unbundling obligations is
imposed principally to oblige Telecom to share its existing customer base, which undeniably
confers a substantial competitive advantage on the firm in a converged market, then the
legitimacy of this objective should be analysed separately from any issues of infrastructure
competition.
As the analysis undertaken using the ladder of investment approach appears to suggest that
there are few barriers to replicability (as evidenced by existing entry patterns, in many
markets at least), then it cannot be discounted that the customer unbundling is the principal
objective of the regulatory change (and indeed has been the principal outcome of unbundling
policies in the rest of the OECD, where there is little evidence of extensive investment in
total, and none of unbundled infrastructure investment leading to full-scale facilities-based
competition).
To pursue customer unbundling by inappropriately pursuing ‘ladder of
investment’ infrastructure unbundling may address the customer unbundling, but at the cost of
substantial distortion to the incentives to invest in infrastructure. That Telecom’s ‘failure’ to
meet bitstream targets has been judged against a standard of ‘not enough’ of the connections
being sold by new entrants suggests that, at a regulatory level at least, customer unbundling is
an important objective. Substantial caution would appear to be indicated if Cave’s costly
consequences are to be avoided.
5.2.2
Second, Populate the “Ladder” and Design Customised Climbing Incentives
Cave identifies that, having established which infrastructures it is feasible to duplicate, both
entrants and incumbents must be ranked on the ladder, their likely and actual investment
potential over the period of the intervention identified, and then customised incentives
designed to stimulate each firm to climb according to their individual trajectories (p 233). As
different entrants may be at different levels on the ladder at any time, and that different levels
of infrastructure investment may be desirable in different localities, the contracts to induce the
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entrants to climb need to be determined not by the state or costs of the incumbent’s
investments, but the current absolute and relative positioning of the entrant and the relevant
market in which the investment is being incentivised. This analysis should also take account
of the position of entrants relative to each other: “if a competitor is just below another on the
‘ladder’ or is on the same rung in an adjoining market, its entry potential should be taken into
account” (p 231).
Cave notes that the instruments to incentivise ongoing investment might be either price or
quantity-based, and that it may be necessary to increase prices for unbundled elements across
time to discourage entrants from staying too long on any one rung. He also identifies that
interventions must allow for new entrants joining at lower levels at later dates, and the
desirability of these entrants being able to buy unbundled elements off not just the incumbent,
but other entrants who have invested in their own infrastructures further up the ladder.
Indeed, Cave’s approach suggests that each entrant will ideally have its own customised set of
incentives in such an environment, rather than a single set of terms and conditions applying
universally. Moreover, Cave’s approach suggests that the terms of the regulatory intervention
are set not by the costs and conditions prevailing upon the incumbent, but on the costs and
conditions prevailing upon the entrants – that is, regulatory metrics in a fully operational
ladder will be determined by principally by entrant, rather than incumbent, characteristics.
5.2.2.1 Yet the Bill Sets Intervention Criteria Using Telecom Network Characteristics
Cave’s ideal scenario is diametrically opposite to the terms contained in the Bill. Firstly, Part
3 of Schedule 2 requires that the designated access services (local and sub-loop unbundling,
co-location and backhaul) be provided only by Telecom and not any other entrants with the
capability to provide the services, but also in the first instance on terms and conditions “on
which Telecom provides the services to itself”. Importantly, the elements will be supplied at
a single price to all entrants, rather than customised to each entrant dependent upon
existing positioning on the ladder. The regulated prices for each element will be set initially
using “benchmarking against prices for similar services in comparable countries that use a
forward-looking cost-based pricing method”, but the final prices will be based upon TSLRIC
principles. Thus, prices would appear to be universal, without necessarily being sensitive to
regional or local characteristics and entry patterns, and determined by theoretical incumbentbased network costs rather than being conditional upon entrant characteristics.
A further very real concern is the absence of any consideration in the provisions for the
important issues identified by Cave with respect to the incentives offered to entrants relative
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to each other. The Bill is framed only to address relativity between Telecom and entrants as a
group, rather than individually, and there are no provisions to utilise any relativities between
entrants to stimulate investment. The one-sided nature of the provisions adds further weight
to the possible conclusion that the underlying element being unbundled is Telecom’s
customer base, and that it does not matter which entrant ‘gets to use it’, as in this respect, all
entrants are equal. Thus, no incentives would be necessary to stimulate competition between
entrants, as the customer cannot be duplicated.
Thus, it is highly unlikely that the proposals in the Bill will result in a principled ladder of
investment approach to infrastructure investment. Rather, it would not be surprising to find
that considerable distortions will occur, due to these entrant-specific characteristics being
overlooked.
5.2.2.2 TSLRIC Prices Decline over Time, Disincentivising Investment
Cave identifies the usefulness of increasing the prices of unbundled elements across time to
prevent entrants from becoming entrenched on any one rung of the ladder. Whilst the single
New Zealand price indicates a static, rather than increasing price, suggesting an absence of
incentives to climb, the use of TSLRIC prices may actually lead to negative incentives
(‘rewards’) inducing entrants to delay investment further. As it has typically been observed,
the price of a theoretically efficient telecommunications network decreases successively
across time as technological improvement results in cheaper and more capable equipment
being deployed. Thus, it would be expected that the theoretical TSLRIC prices for elements
might decline across time, rather than increase as suggested is desirable when utilising Cave’s
ladder. Entrants aware of this feature who have access to unbundled elements may withhold
investment themselves, simply because the reducing prices for elements actually make not
investing more desirable as a medium or long-term strategy. Rather than investing, waiting
for lower-priced incumbent elements is optimal (Guthrie, 2006).
Thus, the use of TSLRIC pricing appears quite incongurent with the implementation of the
ladder as a tool incentivising future facilities-based competition. .
5.2.2.3 Removal of Section 65 Sunset Clause
Furthermore, using TSLRIC Prices, not only will the unbundled elements fall in price across
time, but the sunset clause present in the current Act providing for “automatic expiry of a
designated or specified service on the expiration of 5 years from the date on which the service
came into force” that applies in Section 65 of the current Act is removed.
Under the
provisions of the Bill, not only will prices get lower over time, but unlike the situation
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applying originally in Canada, there is no mandatory removal of the infrastructure projected
to provide strong incentives for entrants to keep climbing. This appears quite inconsistent
with the need for incentives to keep entrants climbing the ladder.
The likelihood of entrenchment of unbundling is further enabled by the very vague
obligations that replace the sunset clause. The replacement clause (clause 58) amending
Schedule 3 requires only that the Commission “consider, at intervals of not more than five
years after the date on which a designated service or specified service came into force,
whether there are reasonable grounds for commencing an investigation into whether a service
should be omitted from Schedule 1” (Bill Digest, p 7). That is, it is not even mandatory to reevaluate the designating of a service at 5-yearly intervals – the only obligation on the
Commission is at least once every five years to decide whether it is necessary to recommend
an evaluation be undertaken. Thus, it would seem once an element has been designated, it
would be extremely unlikely that it would ever be removed from the Schedule. This clause
suggests that, far from being a transitory strategy, entry based upon unbundled elements is
offered substantial legislative protection as a viable, long-term strategy for entrants.
5.2.2.5 Entrenchment of Current Positions and Lower Investment
Rather than encouraging climbing, the single TSLRIC pricing obligation and the removal of
the sunset clause appear more likely to lead to entrenchment of entrants on the current rung of
the ladder, and overall lower total investment as all entrants await lower regulated prices for
the desired elements. At worst, entrants with their own infrastructure may cease investments
in these competing elements, and pursue unbundled elements instead, with a reduction in both
total sector investment and inter-platform competition.
5.3
Unbundling and the TSO
Appendix 2 provides a detailed explanation of why the presence of universal pricing may
have been implicated in stimulating over-much entry in urban localities and too little entry in
rural localities, because the prices faced by consumers, upon which entrants derive their likely
future revenue projections, and therefore the viability of the entry decisions, bear little
resemblance to the costs of providing services. As has been identified in the preceding
sections, both telephone and broadband plans are sold at universal prices across the country,
despite the different costs of servicing different locations.
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As long as the expectation of universal pricing remains, and the TSLRIC price is an
‘averaged’ one rather than exchange-specific, it is almost certain that there will continue to be
inefficient excessive entry in low cost markets (i.e. entrants with higher cost infrastructure
than Telecom’s actual costs will enter with their own infrastructure, even though it would be
more efficient to use Telecom’s), and inefficient under-entry in high-cost ones (as the
universal prices are insufficient to generate a fair return on a competitor’s infrastructure that
is less costly than Telecom’s, so the competitor does not invest). If unbundling makes entry
easier, then the costs of inefficient entry decisions will likely increase, relative to the present,
exacerbating the difficulty of calculating and reallocating obligations and compensation under
the TSO, and raising total costs to the industry.
However, the Regulatory Impact Statement states that “the net cost of the TSOs to the
industry is unlikely to increase as a result of the proposed changes. Rather, the changes are
expected to distribute the TSO burden more equitably amongst service providers and bring
greater competitive neutrality (which will increase efficiency)”. It is difficult to reconcile this
statement with the above theory. Rather, it would appear that it is extremely unwise to
promote further entry into the market whilst the distorting effect of universal pricing has the
potential to exert very substantial biases upon entry decisions.
5.3.1
Geographic Averaging and ‘Predatory Pricing’
There is no doubt that entry decisions have already been distorted by prices that do not reflect
actual costs. Extensive use of averaged pricing is precisely the reason why entrants prefer the
low-cost areas for their entry – prices are artificially high, and real costs low, so the best
margins are in these areas. That incumbents are able to reduce their prices in these regions to
match entrants is not predatory pricing, but simply the reduction of margin and a normal
competitive practice that occurs when dominant firms are faced with competition.
Thus, it is incongruous that the Stocktake authors should suggest that the laws relating to
price discrimination in the telecommunications sector be revised to prevent Telecom (or any
other infrastructure owner, for that matter), reducing prices to compete with new entrants
(para 81). The predatory pricing provisions of the Commerce Act are quite adequate in this
respect, and there is no need for further punitive measures to be applied to Telecom to the
extent that it is less able than any other firm to act in a typically competitive manner, simply
because it operates in the telecommunications market.
If the proposals were genuinely neutral and designed to promote vibrant competition between
all participants, then it would not matter which firm managed the customer relationship, as
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long as consumers get to benefit from wider choice in product price and quality, and face no
impediments to switching providers. To deprive Telecom of the opportunity to respond to
competitive threats is actually harmful to consumer welfare, as it deprives consumers of the
price and product variety that will emerge if Telecom is able to respond innovatively to the
presence of entrants.
5.3.2
Timing of Geographic ‘De-averaging’
That the suggestion should ever be made about restraining Telecom’s ability to respond in a
normal competitive manner is a direct consequence of the distorting effects that
geographically averaged prices have in markets where there is more than one provider. The
unwillingness of successive governments to address the issue of the distortions that arise
under the geographically averaged price obligations of the Kiwi Share/TSO when there are
multiple participants in the market is therefore directly responsible for the occurrence of both
entrants’ and Telecom’s pricing behaviour. If prices in the market were allowed to vary with
variations in costs, then there is no need for any of the expensive monitoring, calculating and
compensating that must occur when allocating obligations such as those under the TSO.
Moreover, with the TSO being calculated and levied in arrears, the considerable degree of
uncertainty about what a potential entrant’s TSO obligation might be will inevitably lead to
poor investment decisions, as no provider can accurately forecast the effect that new entry by
other players will have upon market shares and TSO obligations.
Thus it would appear to be somewhat illogical to first introduce regulations encouraging entry
on the basis of averaged prices, and then revisit the obligations that the averaged prices create
after the complications have been incurred, only following unbundling with potentially many
more parties involved in the process. The reallocation process is simply an additional set of
transaction costs imposed upon the industry, as they add no value in themselves, and divert
resources away from the delivery of products and services, as participants prepare data and
lobby the regulator in pursuit of individually advantageous decisions. Yet this is precisely
how it is proposed that the unbundling timetable will proceed – the timetable (Stocktake, p
18) indicates that unbundling will be introduced simultaneously with the preparation of a
paper reviewing the TSO. Thus, no changes to the TSO will be made until unbundling is
already entrenched.
The timing of the TSO issue is quite puzzling, given that the OECD has drawn attention to the
imperative of rebalancing “subscriber prices and in particular fixed subscriber line charges so
that they reflect costs” (OECD, 2003:13) in order to send the appropriate price signals to new
entrants. Quite simply, the OECD warns that geographic averaging policies are inconsistent
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with unbundling policies: “rebalanced prices are important for new entrants wanting to take
advantage of unbundling since without rebalanced prices new entrants with a business model
focusing on low-value services can be caught in a price squeeze and may be unable to offer
services at competitive prices” (ibid).
If prices charged to entrants for unbundled elements
are actual cost, geographic averaging of retail prices breaks down, as both incumbents and
entrants must charge cost-based prices. However, if loops are charged for at average cost,
then new entrants will inevitably cream-skim by supplying services only to the most
profitable customers, leaving the less profitable ones to the incumbent. Whilst the OECD
notes the political difficulties of addressing this issue, it is not insurmountable, as evidenced
by the policies in Canada.
It would be unfortunate if, in the haste to progress to unbundling, the consequences of the
existing regulatory impositions on Telecom were not given adequate consideration, with the
consequence of further, costly, efficiency-reducing obligations being placed upon the industry
in respect of the TSO.
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Conclusion
The discussion of the five key variances between my analysis of the New Zealand
information transfer markets and that of the Stocktake authors and their advisers illustrates
that the case for proceeding with full unbundling is by no means straightforward. There is a
very great amount of disagreement amongst academics, policy-makers, industry analysts and
market participants about the efficacy of the policies. As best the evidence in support of the
policies is unconvincing; at worst it reveals that in certain circumstances it has been directly
implicated in unequivocally negative outcomes.
Even if unbundling was implemented using the ideal circumstances espoused for the ‘ladder
of investment’, the risks associated with the policy are very high. If, as shown above, the
benefits are likely to be at best marginal, despite the opportunities to learn from the
experiences of other countries, and given that much of the activity that has occurred in
broadband markets worldwide appears to have occurred despite of, rather than because of, the
presence of unbundling, on balance there does not appear to be a strong case to proceed. If
there was concrete evidence available supporting its efficacy, then there might be merit in
proceeding. However, the concrete evidence available pertains almost exclusively of the
costs associated with unbundling when it has not been optimally applied.
As an academic practitioner, using scientific methodologies, I can find no compelling
evidence in the international body of theoretical or empirical literature that would support the
degree of faith the Stocktake authors and their advisers place in the proposed policies to
achieve the articulated objectives. I strongly submit that these methodologies show that the
analysis the authors have provided for your consideration is unscientific, cursory in its use of
the body of literature available on the subject, at times contradictory and inconsistent,
occasionally factually incorrect and possibly even methodologically biased towards
supporting a finding of competition ‘problems’ in respect of a single company. I submit that
this result shows a need for caution in using their analysis as the sole basis for such an
important policy decision.
My analysis is by no means complete, as I have focused only upon the key elements deemed
by the Stocktake authors to be the ones pertaining to your immediate decision. However, I
would commend to you the very thorough analysis undertaken by the Telecommunications
Commissioner in the 2003 Section 64 Review, and the review undertaken by the FCC in 2004
in relation to the removal of obligations from broadband providers in the United States. The
issues raised in both of these reviews continue to be relevant to the ongoing debate. Both
8/11/2006
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summarise many more issues than I have been able to address in this submission. Both find
that the degree of complexity, the unproven effects of unbundling in an embryonic, immature
market, the importance of information transfer infrastructures in a modern economy and the
high degree of technological uncertainty in the relevant markets mean that it extremely risky
to impose obligations of the kind required in unbundling. The results might be positive. But
on the other hand, they might be very costly. On balance, as the concrete evidence is of the
costs, and the benefits remain largely theoretical, both reports endorse a precautionary
approach of not intervening, at least until there is more evidence of the efficacy of the
approach.
I take this opportunity to thank you for considering this submission. It is my considered view
that the substantial “reasonable doubt” raised by this submission about the likelihood of the
proposed legislation in its current form being unequivocally positive for New Zealand leaves
the case for proceeding “not proven”.
8/11/2006
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Appendix 1. Unbundling Telecommunications History
Telecommunications markets differ fundamentally from the markets for many other goods
and services because the capital required is typically very large, and is tied up predominantly
in fixed assets specific to the production of telecommunications services. These assets are
‘sunk’,
as
their
costs
are
neither
avoidable
nor
recoverable.
Consequently,
telecommunications markets are characterised by significant economies of scale, leading to
challenges for policy-makers in the design of the regulatory environments in which these
firms operate (Laffont and Tirole, 2000). Large economies of scale typically result in few
firms investing, and markets with limited competition. However, restrictions in competition
may be necessary in some circumstances to provide sufficient incentives for investors to
commit their capital to these large, sunk investments, especially where it is economically
feasible for only one firm to invest (natural monopoly).
This is especially important when
investments are made in new technologies. A potential investor may be reluctant to commit
to building the new infrastructure if another investor may also invest, placing the ability to
receive an economic return on the original investment in jeopardy. In these circumstances, a
‘prisoner’s dilemma’ arises – no investors are prepared to sink investments, and valuable new
networks are not built. Consumers are denied the benefits that these new networks would
confer (Carlton and Perloff, 1999).
These economic characteristics have shaped the ways in which telecommunications markets
and their regulatory environments have evolved (Wallsten, 2006). During the late nineteenth
and early twentieth centuries, in order to encourage investment in the original ‘plain old
telephone systems’ (POTS), protection from competition for their owners was the norm. Two
predominant models of investment and regulation emerged: the ‘private sector’ model (for
example, in the United States), where private investors were granted a geographical territorial
monopoly by state authorities, but were subject to various forms of regulatory restraint upon
prices or profitability (e.g. price caps and rate-of-return regulation); and the ‘public sector’
model (for example in the United Kingdom, Australia and New Zealand), where territorial
governments (local, state or national) built the networks using tax revenues, and safeguarded
these investments with laws making it illegal for anyone other than the relevant government
authority to operate a telephone network (Cave and Crandall, 2001).
Whilst these regulations were pivotal in stimulating initial investment in the networks, over
time a body of evidence began to emerge that, under the monopoly arrangements, neither the
public owners nor the private owners had strong incentives to constrain operating costs (static
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efficiency concerns) or to engage in incremental investment in innovative new products and
services provided on their networks (dynamic efficiency concerns).
Whilst industry-led
investment in innovation did occur, it was typically confined to technologies that enhanced or
further entrenched the existing owners’ monopoly positions (e.g. the telephone companies
jointly owned industry-wide research and development facilities, such as Bell Laboratories).
The incentives for commercially-funded research and development to occur in completely
new technologies that would challenge the POTS were negligible, because the regulatory
restrictions prevented investors in alternative technologies from competing commercially with
the incumbent providers (Crandall and Hausmann, 2000).
Consequently, innovation in
alternative technologies was confined principally to academic and military institutions.
By the latter half of the twentieth century, the size of the static efficiency losses from the
regulated monopoly arrangements was becoming a significant concern. Backed by emergent
research about the strength of incentives provided by a defined private ownership stake in
reducing static efficiency losses (e.g. Coase, 1960; Alchian and Demsetz, 1972); Grossman
and Hart, 1986; Demsetz, 1988; Hart and Moore, 1990), regulators in markets with stateowned POTS started looking towards privatisation as a means of improving sector efficiency.
These theories suggested that a single private owner subject to regulation, as in the ‘private
sector’ model, would outperform the ‘public sector’ POTS simply because private owners
with a vested financial interest would be more vigilant in their monitoring of managers in
order to ensure that an adequate rate of return on capital was made, than state-appointed
agents with no vested financial interest.
The near-universal acceptance of this policy is
attested to by the rapid move to privatisation of telecommunications companies across the
OECD since the 1980s (OECD, 2005).
Meanwhile, regulators in the markets with privately-owned POTS started exploring other
avenues whereby static efficiency might be improved. Given that the natural monopoly
nature of the businesses (at that time) precluded two firms competing with each other on
different infrastructures, these regulators began exploring the possibility of structurally
separating parts of the business and providing a path for competitive provision of, if not full
network services, then at least some parts of the POTS business. By requiring incumbent
providers to offer ‘designated’ bundles of their services at prices determined by the regulator
to other firms, who could then ‘repackage’ them with other services added, costs and prices
would fall, incremental service innovations would be made (at least in terms of the newly
competitive ‘downstream’ services), and consumer welfare would rise. These regulatory
strategies have become known generally as ‘unbundling’: the incumbent provider is required
to ‘unbundle’ elements of the integrated service and offer them on equal terms to any
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potential buyer. The buyers can then compete with each other, and even with the incumbent,
if it is allowed to also provide the service element, to provide services to end consumers
(Crandall and Hazlett, 2000). However, the core elements of the service that benefit from the
economies of scale – that is, the products and services provided using the sunk investments of
the incumbent – are still provided by a single monopoly company. The incumbent’s returns
are constrained by the controls placed by regulators on the terms and conditions under which
the incumbent must offer ‘designated’ services to all comers (for a detailed discussion, see
FCC, 2005a).
Together, privitisation and ‘unbundling’ have characterised worldwide regulatory reform of
telecommunications markets over the past two decades. In many cases they have occurred
concurrently (e.g. in most of Europe). In the already-private markets such as the United
States, the focus has been on unbundling. In some previously public-dominated markets (e.g.
New Zealand and the United Kingdom), privatisation has preceded unbundling (OECD,
2003). However, it is important to remember that at the core of the ‘unbundling’ strategy sits
the presumption that provision of telecommunications infrastructure is a natural monopoly
that will not be subject to competition by any other provider or technology type.
‘Unbundling’ contracts have developed across time from simple ‘wholesale’-type
arrangements where network-based service elements are offered by a network provider on a
non-discriminatory basis to a variety of retailers who repackage and on-sell them to end
consumers (e.g. retail competition and ‘bitstream’ access) to complex lease arrangements
where the incumbent is required to lease physical access to elements of the core network
infrastructure to a competitor. Depending upon the terms of these lease arrangements, the
new entrants may be allowed to deploy their own equipment within the incumbent’s network,
in order to provide technologically-differentiated services to end-consumers. These latter
arrangements have become commonly known as ‘local loop unbundling’.
The network
element that is deemed to be the natural monopoly owned by the incumbent is the ‘local loop’
– the copper wires linking end consumers with local telephone exchanges. ‘Local loop
unbundling’ agreements define the terms and conditions upon which the incumbent must
lease to the new entrant both the copper leading to a specific end consumer, and the requisite
space and services within existing facilities to enable the new entrant to ‘bolt in’ the
differentiated equipment allowing different services to be provided. These agreements thus
allow new entrants the ability to provide an entire range of competing services, from a ‘rebranded’ incumbent service to one that is fundamentally different, and based upon technology
investments made by the new entrant.
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The appeal to regulators of full-scale local loop unbundling over simple wholesale
agreements lies in its potential to overcome not just the static efficiency problems, but also
some of the dynamic efficiency disadvantages of a single regulated monopoly. If many
companies can lease access to the natural monopoly element, then there may be competition
in the other elements that are not of themselves subject to economies of scale. This is thought
to stimulate investment in research and development, and in the deployment of the
differentiated technologies that result, by entities other than just the incumbent.
Theoretically, this will lead to greater product and service variety and end-consumer welfare,
without compromising the economies of scale arising from having a single underlying natural
monopoly infrastructure (Shelanski, 2002). The combined appeal of both static and dynamic
efficiency gains promised from the competitive effects of local loop unbundling have resulted
in it becoming a near-universal policy in OECD countries. The United States mandated it in
the 1996 Telecommunications Act and a condition for membership of the European Union is
that countries have an unbundling policy approved by the Commissioner.
Non-aligned
countries such as Canada, Japan and Australia have implemented unbundling policies. Both
Switzerland and New Zealand have signalled policy intentions to pursue unbundling, though
neither country has yet succeeded in passing the necessary legislation to implement it.
The difficulty with unbundling comes, however, with the ways in which it alters the
investment incentives for the entire sector. Whilst new entrants have the opportunity to
compete using the incumbent’s investments, unless the prices set by the regulator for the
access allowed adequately compensate the incumbent for the investments already made on the
natural monopoly elements, and provide sufficient incentives to ensure continued
maintenance and upgrading of this infrastructure, a new set of dynamic investment problems
is engendered (Crandall, Ingraham and Singer, 2003). Whilst setting prices low may be
desirable initially to stimulate entry, and to reduce substantial productive inefficiencies within
the incumbent (e.g. those arising from historic public ownership), across time the effects of
unbundling may be profound.
If prices are set too low, the incumbent cannot recoup a
sufficient return to maintain and improve the core infrastructure. Quality falls, putting at risk
the investments made by new entrants in their add-on equipment (Shelanski, 2002).
Furthermore, if the prices are too low, the new entrants face few incentives to invest in
differentiated equipment, as a viable business can be developed simply from resale (Hausman
and Sidak, 2004). Anticipated infrastructure-based innovation and competition does not
develop. For example, whilst 60% of call volumes in the United Kingdom in quarter 2 2005
were billed by competitors to British Telecom (BT), and BT owned the infrastructure for 81%
of lines, fewer than 1% of BT’s lines were sold to competitors under full unbundling
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contracts.
Rather, competition to BT comes predominantly from resellers and other
companies operating duplicate infrastructures (Ofcom, 2005).
Similar findings come from
the United States. Despite full unbundling being in place for ten years, new entrants have
invested in their own equipment to service fewer than 4.5% of the incumbents’ lines (FCC,
2005).
Moreover, irrespective of the prices set by the regulator, the incumbent will be reluctant to
invest in any new technologies if, as part of the unbundling agreement, all new services must
be made available to competitors on a non-discriminatory basis.
As there are usually
substantial commercial risks associated with new technologies, it may be more profitable and
less risky for the new entrants to lobby the regulator to require the incumbent to invest in new
technologies, and then enjoy the ‘free option’ of selling the incumbent’s services without the
associated risk of having to invest the requisite capital.
If the new technology is not
commercially successful, the new entrant can costlessly exit the market, whilst the incumbent
is left with costly sunk and stranded assets. As the incumbent can anticipate this effect in an
‘unbundled’ environment, the incentive for the incumbent to invest in new technologies is
consequently less under unbundling than under regulated monopoly.
The uncertainty
associated with new technologies means that it is virtually impossible for a regulator to set the
unbundled price to adequately compensate for the ‘free option’ provided to new entrants.
Thus, the ‘safe’ option for the incumbent is simply to continue selling existing products and
services. The rate of implementation of new technologies may actually be slower than under
regulated monopoly, simply because the incumbent is unable to price the new product in a
manner that recoups this investment risk (Crandall, Sidak and Singer, 2002).
In addition, unbundling does not overcome the dynamic ‘problem’ associated with all
commercial research, development and investment being focused on the telecommunications
network, at the expense of other non-telecommunications technologies that may render the
telecommunications natural monopoly redundant.
Unbundling, especially if the prices
charged inadequately compensate for the risks of new technology implementation, may lead
to a ‘crowding out’ of investments in researching and developing new technologies.
New
research and development spending, and infrastructure investment, are further skewed
towards telecommunications infrastructures, ironically further entrenching the monopoly of
the underlying infrastructure relative to potential competing infrastructures (Hazlett, 2002).
Thus, incumbents facing competition from alternative infrastructures may actually welcome
unbundling, as it strengthens the competitive position of their core infrastructures relative to
the alternatives. As with all network effect products (e.g. computer operating systems), the
more investors whose businesses are bound up with investments in the telecommunications
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infrastructure, the greater the ‘lock-in’ and the less threat the incumbent faces from them
‘switching’ their investment to alternative technology platforms (Shapiro and Varian, 1999).
The dynamic investment issues have been especially important in respect of the competitive
challenges that have emerged for telecommunications networks with the advent of a new
technology – the Internet. Whilst the technologies underpinning the POTS relied upon a
specific set of infrastructures – copper, switches and exchanges – to deliver a specific product
– switched voice telephony services – technological advances, including the development of
the Internet, digital communications, packet switching, wireless and cellular telephony,
satellites and fibre optics have led to a removal of the ‘natural monopoly’ in communications
offered by the core copper-based POTS infrastructures.
Whilst regulators have used
unbundling to facilitate competition on the POTS, the selfsame policies are now threatening
to offer an overly-strong advantage to telecommunications providers over the providers of
other information communication infrastructures (such as fibre-optic cable, wireless, cellular
and satellite) in the development of competitive markets for the delivery of generalised
information exchange services (Howell, 2003).
Whilst POTS-based infrastructures are
capable of delivering such services, it is not at all clear that they should be especially
advantaged by regulation in the dynamic deployment of these new technologies (Hausman,
2002), or that copper connections constitute a natural monopoly in the delivery of these
services to end consumers (FCC 2005a; Hahn and Wallsten, 2006).
With these factors in mind, regulators are beginning a new phase of regulation in respect of
services delivering Internet connectivity (often termed ‘broadband markets’).
The United
States Federal Communications Commission (FCC), the regulatory authority that pioneered
‘unbundling’, has now backed away from ‘designating’ broadband services at regulatordetermined prices in favour of commercial contracts negotiated between providers (FCC
Decision 05-150).
Incumbents and new entrants are able to enter into ‘unbundling’
agreements on commercial terms, even though telecommunications incumbents have a
monopoly in copper, because they do not have a monopoly in broadband connection potential.
This is seen as especially important in the developing markets for broadband connections, as
the penetration of broadband connections is still far from ubiquitous and it is not presently
clear which of the competing infrastructures (copper, fibre-optic cable, wireless, cellular,
satellite, or some as yet-uninvented technology), if any, will become dominant. As a variety
of new technologies have the capacity to deliver broadband services, the FCC has no desire to
artificially advantage one technology over any other by setting prices and access terms that
may discourage investment in alternatives. Quite simply, the FCC has accepted that the
historic development of regulation in the telecommunications market should not constrain
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competition in the highly uncertain, and still very new, embryonic broadband market. This
decision has been informed by empirical evidence from in excess of twenty years of evolving
regulatory instruments that confirm that the dynamic investment effects of unbundling are
significant. Ironically, the FCC ruling imposes a regime almost identical to that prevailing
since 1990 in New Zealand, the nation which is currently in the process of overturning a
regulatory regime governed by commercial negotiation in favour of some of the most
stringent unbundling obligations in the OECD.
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Appendix 2. Universal Pricing and Competitive Entry
This example illustrates the distorting effects that universal pricing obligations have upon the
incentives for investment in regulated markets. It also illustrates the strategic responses by
incumbents when faced by competitive entry, and the corresponding obligations that
competitive entry place upon regulators enforcing universal pricing upon the incumbent to
ensure that mechanisms are put in place to compensate the incumbent for the consequences of
competitive entry. The example shows that universal pricing in a competitive environment
may be welfare-reducing rather than welfare-enhancing. The illustration uses the terminology
from the New Zealand telecommunications market, but the principles are equally applicable
to other markets.
The costs of telecommunications networks are very heavily dependent upon the population
densities of the areas they serve. The high proportion of fixed costs in constructing and
maintaining telephony connections means that the average costs per connection in a denselypopulated area are very substantially less than the average costs per connection in a sparselypopulated area. Ideally, in an efficient system, the network operator charges each customer a
connection price reflecting the actual costs. However, telecommunication networks also
embody ‘network effects’ which are independent of the costs of connection. The addition of
one more customer to the network creates benefits in addition to those the new customer gets
from connection, as all existing customers now enjoy the benefits of the externality conferred
from now having the capacity to call one more subscriber than previously. In order to
maximise the welfare of telecommunications networks, regulators in many jurisdictions have
required network operators to charge customers in all areas a ‘universal’ connection price. As
long as the universal price is set to ensure that the gains from the network externalities exceed
the deadweight losses arising from some consumers in low-cost areas no longer buying
connections as a consequence of facing higher connection charges, there will be no net loss of
welfare from the imposition of such a price. As there is only one operator, there is no need
for an explicit transfer to subsidise loss-making connections from the surpluses generated
from profit-generating ones.
Basic Model
The following stylised example illustrates this outcome.
Presume there is one network
operator, serving two populations – a densely-populated urban population, where the marginal
cost of adding a new connection is MCU , and a sparsely-populated rural population, with
marginal cost MC R . Also presume that the consumers in each area have the same demand
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for connections, represented by D.
Figure 1 shows that the if the operator charges a price
equal to marginal cost to each customer group, then QU connections will be sold in the urban
area and Q R in the rural area..
Figure 1. The Basic Model
Price
MC R
MCU
Demand
QR
QU
Quantity
Universal Pricing
Suppose, however, a regulator mandates that a universal price be charged to consumers in
both areas. Such a price has historically been charged in New Zealand for local residential
connections since the inception of the initially government-owned telephone network. The
obligation to have such tariffs was imposed upon Telecom New Zealand when the firm was
privatised in 1990, as part of a bundle of obligations known as the ‘Kiwi Share’.
Presume that the regulated universal price is PK , which is somewhere between MC R and
MCU . There will now be Q K connections sold in each of the urban and rural areas. Those
customers in rural areas unwilling to buy at P = MC R will buy at P = PK . At the new price,
the network operator incurs a loss from supplying rural consumers at the universal price,
shown as the combined area covered by the red dotted rectangle and triangles.
However,
these losses are compensated for by the fact that the urban customers are now paying above
cost, generating a surplus, shown by the red cross-hatching. As long as the surpluses cancel
out the losses, the operator will break even. There is, however, a dead-weight loss – the
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striped triangle – representing those urban consumers who would have purchased connections
at the lower P = MCU , but who do not at the higher P = PK . As long as the value of the
network effects from having more consumers on the network and the additional welfare
derived by the consumers who would not have purchased at the rural price (represented by the
solid dotted triangle within the dotted red rectangle) exceed the size of the deadweight loss
(the red lined triangle) then universal pricing will be welfare-enhancing in total.
Figure 2. The ‘Kiwi Share’ Model
Price
MC R
PK
MCU
Demand
QR
QK
QU
Quantity
Universal Pricing and Competitive Entry – Identical Costs
Now presume that the single network provider is subject to competitive entry by a competitor
with the same cost structure.
Note that it is the very presence of producer surpluses in the
urban market as a consequence of the universal pricing requirement that will induce
competitive entry in the urban market. The new entrant will not consider entry in the rural
market, because this will lead to losses.
The newcomer enters the urban market and charges a price PE , which is less than PK 29. At
the lower price, the number of urban consumers expands to Q E . The incumbent must either
29
The new entrant’s price will presumably have to be lower than the incumbent’s by a non-trivial amount to induce consumer
switching.
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match the new entrant’s price, or risk losing all urban customers. Any loss of customers
threatens the ability to subsidise the more costly rural consumers. Thus, the least damaging
strategy is for the incumbent is to match the new entrant’s price. Under this strategy, both
providers share the market (for arguments sake, 50% each). Thus, an incumbent in a system
with universal prices responding to entry by lowering prices in the low cost market is not
engaging in predatory pricing – the response is necessary simply to retain customers and the
income streams from which to cover the deficits incurred from servicing the rural market.
Assuming that the new entrant’s cost is the same as the incumbent’s, total profits in the urban
market are now represented by the two green dotted rectangles. Entry leads to an increase in
consumer welfare in the urban market. The number of urban customers increases from QU to
QE and the profits represented by the red dotted rectangle, previously accrued by the
incumbent to offset higher costs in the rural areas, are transferred to existing consumers in the
form of lower prices.
Figure 3. Urban New Entrant Model – Identical Costs
Price
MC R
PK
PE
MCU
Demand
QR
QK
QE
QU
Quantity
However, the very act of entry has impinged upon the incumbent’s ability to subsidise the
rural consumers. The incumbent has lost all surpluses represented by the red dotted rectangle
to consumers. Furthermore, profits represented by half the light green dotted rectangle have
been transferred from the incumbent to the new entrant. The incumbent has accrued half of
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the additional profits associated with new customers (i.e. half the the solid green dotted
rectangle), but it is unlikely that these will compensate for the losses associated with the
transfers to consumers and the new entrant. Thus, the incumbent is now unable to subsidise
the rural consumers to the extent possible in Figure 2.
This leaves the incumbent with two options – raise the price to rural consumers, or petition
the regulator for compensation for the lost profits. If prices to rural consumers are raised,
then there will be a loss of welfare in the rural market as the number of connections contracts,
and the network effects from these consumers buying connections are lost. Such an act thus
violates the social principles that underpinned the requirement for a universal price in the first
place. Rather, the regulator is more likely to favour taxing the new entrant in order to
compensate the incumbent for lost profits.
This is the justification for the
‘Telecommunications Service Order’ (TSO) imposed on new entrants in New Zealand to
compensate Telecom New Zealand for providing ‘unprofitable’ connections.
Sensitivity to Entrant’s Costs
Clearly, the presence of a universal service obligation has distorting effects upon the
incentives for entry into telecommunications markets. Unless there is clarity about the extent
of the subsidy occurring in rural markets, and the obligations upon new entrants to meet these
costs as part of their business case for entering, the incumbent’s universal prices alone may
induce inefficient entry behaviour. Entry will be efficiency-raising only if the entrant’s cost is
lower than that of the incumbent in the market entered. Entry by a competitor with any other
cost structure actually leads to a reduction in total welfare.
Urban Market Entry
Entry in the urban market by a firm with higher costs than the incumbent illustrates the
efficiency loss. Returning to Figure 3, now assume that the entrant’s price is actually its
marginal cost – that is, PE = MCUE . Under this scenario, only the incumbent earns profits.
The profits represented by the green dotted rectangles are only half what they were under the
Figure 3 scenario where providers’ costs were equal. Entry by the higher-cost provider has
resulted in a reduction in total welfare, as there is only half as much profit with which to
compensate the incumbent for providing the unprofitable rural customers. As the new entrant
is making no profits, it is futile to impose a TSO tax, as there are no profits from which to
make the tax payment. Unless the exact size of the required TSO tax is known in advance by
potential new entrants, and factored into their entry decisions, there is a very real risk that
inefficient entry will occur (it is noted that in New Zealand, the TSO obligations paid by new
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entrants to Telecom are calculated and paid in arrears – in August 2006, the 2004-5
obligations had still to be set).
Even if the new entrant’s costs are identical to the incumbent’s, the net effect of a TSO tax
will simply be to increase the costs of the new entrant to such an extent that the surpluses
earned by and transferred to the incumbent exactly equal the red cross-hatched rectangle in
Figure 2. Absent transaction costs, this can only be achieved by both firms charging PK –
that is, return to prices and quantities as in the single provider market. In practice, however,
the transaction costs associated with administering the tax will mean that prices must rise
above PK . The total number of urban consumers actually reduces. The overall effect of
entry by a firm with identical costs under universal prices is actually a net reduction in
welfare, due to the additional costs of redistributing profits to the incumbent to continue
providing subsidised rural services. Welfare will increase only if the new entrant has a lower
cost structure than the incumbent (i.e. MCUE < MCU ), and can use the additional profits
arising from the lower costs – that is, the blue dotted rectangle in Figure 4 pertaining to the
entrant’s share of the market - to both compensate the incumbent (the TSO tax) and cover the
transaction costs of the transfers necessary to maintain the rural subsidies.
Figure 4. Urban New Entrant Model – Lower-Cost Entrant
Price
MC R
PK
PE
MCU
MCUE
QR
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QE
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QU
Quantity
Rural Market Entry
The second major distortion relates to the subsidised prices pertaining in the rural market. As
PK < MC R , a new entrant with a marginal cost MC RE greater than PK , but still less than
MC R , as it will not be able to recover costs. The new entrant would be able to serve the rural
market at lower cost than the incumbent, requiring a smaller subsidy (the pink dotted
rectangle in Figure 5 is smaller than the red dotted rectangles in Figure 2) than that required
by the incumbent. However, without a pre-arranged subsidy, there will be no entry. The
costs saved (the difference between the red and pink dotted rectangles) will be forfeited.
The presence of universal pricing thus disincentivises welfare-raising entry into the rural
market, at the same time as it encourages inefficient entry into the urban market. The obvious
‘solution’ to these distortions would be to allow prices in each market to reflect costs. Whilst
this may result in fewer consumers in the high-cost rural areas, and lower welfare from
network externalities, this must be traded off against the greater number of urban consumers,
the costs of distortions, and the costs of alternative regulatory regimes (e.g. the TSO) to
compensate for the effects of entry. As this example illustrates, this is not a simple exercise.
If there is a real welfare gain from having universal prices, in a multi-provider market such
policies might be achieved with less distortion to the market for the supply of services by
allowing prices reflecting actual costs to be charged, and compensating users facing high
prices via other means (e.g. lump sum compensation paid via a welfare benefit system).
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Figure 5. Rural Entry Model
Price
MC R
MC RE
PK
MCU
QR
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QE
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QU
Quantity